Understanding Super Pro-rata Rights and Why You Should Avoid Them

Entrepreneurs that have founded a company before and led that business through several rounds of financing probably know what pro-rata rights are and why venture capitalists and other institutional investors request them.

In simple terms, they’re designed to protect those investors from dilution in future rounds, which in turn protects their investment if your company ends up being super successful. For example, if a VC owns 20 percent of your company from the A round of financing, former entrepreneur and current venture capitalist Mark Suster explains on his blog, pro-rata rights allow them to take 20 percent of ensuring rounds.

Seems reasonable and fair, right?

Most would say yes. But, as Suster explains, there’s a huge difference between pro-rata and “super” pro-rata rights. And if you’re a startup or expansion stage founder that’s been asked to agree to the latter, you’d be wise to reconsider.

Super pro-rata rights guarantee an investor the ability to demand more than their initial investment in ensuing rounds. For instance, Suster says that a VC that owns 8 percent of your company after the A round may request as much as 33-50 percent of your next round.

Why is that bad? The simple answer is that those super pro-rata rights might scare off other investors and make it difficult for you to get funding in the next round. Suster goes into greater detail in his post and suggests what entrepreneurs should do if their VC asks about super pro-rata rights.

To read the full article, click here.

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