The Pro-rata Pinch

Below is the ‘Tip of the Week’ transcript from the Podcast Ep44: Negotiating a Term Sheet (Jason Heltzer)

I recently wrote about this in the weekly newsletter and I think it relates well to negotiation and information asymmetry as we discussed today.

Pro-rata or preemptive rights have created quite a stir lately. As angels further organize and syndicate their investments at the seed stage, some VCs have begun expressing frustration. Feld, Wilson, Suster, Walk, Huston and many others have weighed-in on the pro-rata debate. Some supporting the right for angels, some vehemently against it. Most of the arguments against are along the lines of “”They don’t deserve them because they are not actively working with the startup all the way through an exit.”” Others, argue that this is predatory toward entrepreneurs and that angels are taking advantage. Recall that the standard right does not allow one to increase their stake. It merely allows one to retain their ownership percentage, if the investor contributes additional capital.

From my vantage point, I can’t imagine how this would adversely impact an entrepreneur. Would a VC pass on investing in their next potential unicorn because angels are allowed to maintain their stake? If there’s an example of this, I’d love to see it.

To further agitate the situation, a number of VCsย have been making their Series A offers contingent upon the removal of seed pro-rata. I have even heard of cases where notable bloggers, who espouse the merits of angel pro-rata, attempt to eliminate it. This is a particular issue w/ regards to convertible notes where a pro-rata is negotiated outside of a note, via a side-letter, and is not as secure as when it is included in a standard priced-round. The hypocrisy here is confusing and frustrating, to say the least.

It is clear to me that as long as VCs identify the right as predatory, entrepreneurs are wary of it. Ultimately, where do you stand? Is it damaging to fundraising and innovation, or merely a term that smart angels can and should negotiate for? On the website, you’ll find the multiple choice question and it would be great to hear what you think. As usual, I will publish the results in next week’s newsletter.