Understanding Pro Rata Rights

Term Sheets Part IV: Pro Rata Rights

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Daniel Faierman & Chuck Cotter
April 06, 2025

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Daniel Faierman is a Partner at Habitat Partners, an NYC-based early stage VC firm focused on pre-seed to Series A investments in the consumer and software ecosystems. Learn more about Habitat Partners on their website or notion page. Daniel has invested in numerous startups and previously operated and invested at organizations including PepsiCo, AB InBev, VMG Partners, and Selva Ventures. Daniel was a former Yale tennis 🎾 player & completed his MBA at the Stanford Graduate School of Business.

Chuck Cotter is a Partner in Morrison Foerster’s Emerging Company + Venture Capital practice group in Denver, with experience in the consumer products space, including food, beverage, personal care, beauty, and fashion. He has represented such companies and funds in over 200 🚀 consumer financing and M&A transactions. Chuck was a rugby player at Vassar College and completed his JD at Columbia Law School.

Pro Rata Rights ⏯️ 

Back to term sheets! In our most recent term sheets post, we covered everything you need to know about stock options. As we discussed, an increase to a pre-money option pool dilutes existing shareholders. In a similar vein, an investor’s decision to exercise pro rata rights protects their equity ownership position at the the expense of further diluting 1/ existing investors who decide to waive pro rata participation and 2/ founders and employees with common stock.

Also shoutout to my buddy Robby who runs CPG Wire. If you are a consumer brand nerd give it a sub (great weekly overview of all things CPG land). I rarely miss it.

In today’s post, we’ll dive into the following:

What are pro rata rights?

Pro rata rights give investors the right (but not obligation) to participate in one or more future rounds of financing to maintain their percentage ownership in a company. This doesn’t give the right to set the terms of the financing; investors exercise their right and put in additional money on the same terms as everyone else in the new financing round.

What are the different types of pro rata rights?

In most cases pro rata rights are granted on a percentage basis: aka an investor has the right to maintain their ownership percentage in subsequent rounds ➡️ VC Z owned 4% after the seed round and has the right to invest in the Series A to maintain their 4% ownership.

In rare cases pro rata rights may be granted on a:

1/ dollar for dollar basis: gives the investor the right to invest an amount equal to or less than the amount invested in their first round ➡️ VC Z invested $200K in the seed round and has the right to invest $200k in the Series A

2/ fixed sum basis: least common, investors get the right to continue investing an amount as agreed upon that is decoupled from the investment amount. VC Z, who invested $1M in a seed, negotiates pro rata rights up to $700K - they will be able to invest up to $700K in each subsequent round of financing.

In some cases, these rare clauses could trigger super pro rata, which we’ll discuss later.

Pro Rata Rights Video Simulation (Beginner)

I’ve found the best way to exemplify pro rata in action is through a live cap table simulation so please see below for our first pro rata rights demo.

Pro Rata Rights Video example:

Standard Pro Rata Rights Practices for Founders/Investors:

From Chuck’s perspective, any institutional or “meaningful” investor (threshold can vary) can rightfully expect to receive pro rata rights. In a hypothetical $1M SAFE, Convertible Note, or Priced Round, any investor taking up 25% or more of the round could expect pro rata rights.

From Daniel’s perspective, it’s the very least you can do as a founder. Investors are taking a huge risk by investing in your company in the earliest days. Even though that’s part of what being a VC entails, giving your earliest believers the right to at least invest again to sustain their ownership is the right thing to do. Besides, most institutional investors will demand it with minimal flexibility:

Signals associated with exercising vs. waiving Pro Rata rights:

Intuitively, one would think that an investor’s choice to exercise or waive pro rata rights in future rounds is nearly always a strong indicator of how the company is performing. While often true there are exceptions. Irrespective of company performance, fund structure/strategy may dictate a funds ability to exercise pro rata.

In certain cases, a valuation might expand so rapidly between rounds, that protecting ones ownership would be prohibitively expensive for the early-stage VC with pro rata rights. Imagine a smaller sized $15 Mio seed stage fund invested $1 Mio to acquire 10% ownership in Company Z. Two years later, Company Z goes out to raise $20 Mio at a $200 Mio post-money valuation (nice!), thus selling another 10% of the company. Exercising full pro rata rights would require the seed stage fund to invest a full $2 Mio, double their typical check size  

In a case as such, the seed fund may try to go out and raise what’s called co-invest (aka divvy up new capital outside of the fund from LPs/investors in network to unlock ability to exercise pro rata - we’ll discuss in a future newsletter). But they will most likely pass on the opportunity and ride out a strong mark up on their investment. Lastly, certain funds might have deliberate strategies that reduce the likelihood of pro rata participation such as placing lots of diversified bets with minimal follow-on investments. This is very common amongst smaller pre-seed/seed funds in which case power law is in full effect and placing MORE bets is wiser than fewer bets with follow on.

Contrarily, bigger funds might have the ability to exercise pro rata (or even super pro rata) liberally irrespective of required check size. So, while exercising pro rata rights is usually a good signal, not exercising isn’t always a bad one.

Daniel’s perspective: you’re usually wrong in venture so when you’re looking right, it can often make sense to follow on if you have the fund structure to do so… but of course, in a responsible manner, considering the 1/ valuation of the round and 2/ the performance of the company relative to your broader portfolio. Habitat Partners generally follows on in the top 20-25% of performers ONLY.

We love Altos Ventures’ unique take on pro rata here.

SUPER Pro Rata:

Super pro rata is the cherry on top of pro rata. Whereas pro rata gives an investor the right to protect their ownership in future financings, super pro rata awards an investor the opportunity to invest beyond their existing level of ownership in future rounds.

Founders should generally avoid giving this right to investors. Founders want the opportunity to welcome new value-add investors as the company surpasses milestones - super pro rata has the potential to prevent this - if the existing investor with super pro rata wants to take up the entirety or vast majority of allocation in future rounds, there won’t be room for investors that a founder might desire to add to the cap table.

Nonetheless, if a strategic new investor is interested in a future round, cooperative investors with super pro rata would waive the right for the good of the company and its shareholders. Imagine a company building disruptive GPUs to take AI further. An early investor with super pro rata would hopefully be willing to stand down if Nvidia became interested in a strategic investment that cut into allocation.

Variations of Super Pro Rata:

In certain cases, super pro rata clauses can be written with limitations to ensure in a future round a founder can bring in new outside capital with minimal restrictions.

For example: a founder may offer an early investor super pro rata but with a clause that states that if needed, the founder can carve back the investor’s pro rata to 35% of the total round size.

Another example: in certain cases, an investor may be unsatisfied with their level of ownership after partnering with a founder for the first time in a financing. Maybe their fund targets investments that translate to 15% ownership of the company and in this case, they only got 8%. Founders can offer a pro rata clause that empowers the investor to exercise pro rata to the extent that they can reach and sustain 15% ownership of the company in the future.

Final example: in certain cases, founders may offer a lead investor what I would call Pro rata overallotment (or ROFR pro rata). Might be a made-up name on our end. Let’s say a lead investor buys 10% of the company and 2 other smaller investors purchase 2%. All investors are given pro rata rights. In the case that 1 of the 2 smaller investors waives pro rata in a future round, the lead investor can be given the right to the waived investors pro rata portion before any other investor.

Pro Rata Cram Downs: 😠 

Ironically, getting pro rata as an investor DOES NOT always guarantee you’ll be in a strong position to exercise the right in a future financing round even if you want to.

A recent real example: Daniel invested in the pre-seed round of a business in early 2024. The business exploded and reached $6M in ARR 4 months later and was pre-empted with a seed term sheet from a new investor (a good thing!). While Daniel wanted to exercise his full pro rata rights in the round, the round size (dictated by the new lead seed investor) wasn’t big enough for all existing investors with pro rata rights to exercise their rights and protect their ownership.

Legally in this scenario, Daniel could have pounded his fists and demanded his full pro rata…

But that would risk blowing up the deal for everyone. The new lead seed investor defined the round size and the portion they were required to invest. That investor could potentially walk away if defied.

“Fiduciarily” Daniel was incentivized to see the business close the new financing at a higher valuation. So, in the end, Daniel and other prior investors were “crammed down” a bit and forced to invest less than their full pro rata so that the new investment could close.

How the limited pro rata dollars available are allocated in a scenario as such can be tricky. It is a bit of a juggling act between the founder and the pro rata participants often mixed with some annoying politics. 1/ the founder might allocate proportionally based off of how much the prior pre-seed round each investor contributed - for example, if I contributed 25% of the captial in the pre-seed round, the founder would award me 25% of the pro rata dollars available in the seed. 2/ alternatively, the founder might play favorites and allocate based off of which pre-seed investor(s) have been the most helpful since investing! This is where it can get a little dicey (and it happens all the time)

Pro Rata Rights Video Simulation (Advanced)

If you’ve made it this far, I’d definitely encourage you to closely review this second video simulation below, which shows several pro rata scenarios that are more reflective of reality. In the second module in the simulation, you’ll see the scenario described above modeled out!

Pro Rata Video example:

Pro Rata tl;dr Takeaways:

Founders should:

1. Offer material investors pro rata.

2. Avoid offering super pro rata unless there is a unique relationship, or you are in a position of weakness and need to concede to get the round done or secure your top choice investor.

3. Ask investors what their strategy is for follow ons? Do they reserve a certain portion of their funds to do so? What would they like to see to feel confident in following on?

4. Not overthink an investors decision to not exercise pro rata. It’s not always performance-based as their bar may be extremely high… or they may have a deliberate deployment strategy that deters follow on

If you enjoyed this article, feel free to view recent prior articles:

Helpful Sources:

Ongoing Term Glossary

Clawback provisions: provisions that give the company the right to buy back vested shares at the original issue price or at fair market value after dismissing an employee under defined circumstances (leaving for a competitor, severe misconduct, etc)

Co-Invest: triggered when a fund raises “one-off” new capital from LPs/investors (as opposed to pulling from existing permanent fund) to unlock ability to execute an investment; associated management fees and carry (if any) typically flow back to the fund or individual who raised the co-invest capital. Funds often give major LPs prioritized “co-invest“ rights, which gives such LPs the first rights to participate in the co-invest opportunity before others.

Comparable Company Analysis: a valuation methodology that entails identifying comparable companies and transactions to the company being valued as a means of deriving multiples that can be used to generate a landed valuation

Confidentiality: prevents the startup from disclosing the terms of a term sheet to outside parties (i.e., other investors, startups). This enables both parties to negotiate in good faith.

Definitive documents:  the legal contracts between the investors and the company that detail the terms of the transaction and are drafted by a lawyer

Dilution (D): losing a portion of your ownership as the company sells equity to investors

Discounted Cash Flow Analysis (DCF): a valuation methodology that entails forecasting the future cash flows of a business and discounting the cash flows by a determined cost of capital to derive an enterprise value

Down Round: when the pre-money valuation of a future financing is lower than the post-money valuation of the prior financing; often seen as a negative sign for the company

Double-trigger: requires two events to occur to accelerate the completion of your vesting. The first trigger is the acquisition, and the second trigger is the founder or employee getting terminated by the acquirer without cause or good reason in a specified period (typically one year)

Employee Option Pool (EOP): stock that is reserved for existing and future employees to compensate, retain, and motivate workforce

Exclusivity: often referred to as a “no shop,” this provision locks parties into negotiating only with each other for a defined period (i.e., 30-60 days)

Exercise (options): buy options at the strike price

Fund Model: a forecasting exercise that a VC conducts to project what a successful fund will look like in terms of returns from each investment. VCs typically build a pathway to 3.0x net DPI

Lead Investor: primary investor(s) (co-leads can exist) in a funding round that set terms and typically are writing the largest check(s); often take a board seat

Legally nonbinding: refers to the nature of term sheets. A signed term sheet does not legally mandate a deal be completed

Ownership (O): the % of a company a shareholder possesses prior to or post-closing of a financing

Major Investor: refers to a participating investor in a financing that surpasses a certain check size threshold, unlocking certain rights. I.e., “all those who invest over $500k will be deemed major investors and shall receive information and pro rata rights”

Multiple: a ratio that is calculated by dividing the valuation of an asset by a specific item on the financial statements

Multiple on Invested Capital (MOIC): compares the value of an investment on the exit date to the initial equity contribution

Option pool: an amount of common stock primarily reserved in the cap table for future employees (in certain cases, options can be pulled out of the option pool for existing employees/founders as well)

Post-Money Valuation (PO): the valuation of the company after the round size is invested by the VC(s)

Pre-Money Valuation (PM): what the investor is valuing the company at TODAY, prior to the investment

Priced round: a round of financing in which the valuation and price per share of a unit of stock being sold is officially determined (as opposed to a SAFE or convertible note in which case the valuation is left officially undetermined)

Price Per Share (PPS): the cost of acquiring a share of company x, typically determined by pre-money valuation and fully diluted shares outstanding prior to close of financing

Pro rata rights: give investors the right (but not obligation) to participate in future rounds of financing to maintain their initial level of percentage ownership in the company.

Pro rata on a dollar-for-dollar basis: gives the investor the right to invest an amount equal to or less than the amount invested in their first round à VC Z invested 200K in the seed round and has the right to invest 200k in the Series A

Pro rata on a fixed sum basis: least common, investors get the right to continue investing an amount as agreed upon that is decoupled from the investment amount. VC Z, who invested $1M in a seed, negotiates pro rata rights up to $700K - they will be able to invest up to $700K in each subsequent round of financing.

Pro Rata ROFR: gives particular investor(s) the right to another investors voluntarily waived pro rata in a future financing  

Restricted Stock: company stock given to employees, usually as a bonus or additional compensation; does not have a strike price unlike options; usually awarded to company directors and executives and is subject to vesting

Round Size or Investment Amount (R): how much capital the founder is raising for the financing or VC round

RSUs: refers to an agreement by a company to issue employees shares on a future date. One RSU is the right to get one common share. RSUs, like options, are also subject to a time-based vesting schedule and can be trigger based; however, RSUs don’t have a strike price and are instead released directly to the recipient after vesting without any need to “exercise” or buy them; typically awarded to lower level employees than restricted stock

Single-trigger: states that only one event must occur to accelerate the vesting of your equity. If the company is acquired, you gain complete ownership over all your options

Stock options: incentive mechanisms granted to employees, advisors, and consultants. Employees joining a VC-backed startup typically receive an option grant, which allows them to acquire company common shares in the future at a certain price by “exercising vested options”

Strike Price: the predetermined price an employee pays to exercise (aka purchase) their stock options and turn their stock options into actual shares of the company owned outright. Tax regulations (IRS Section 409a) require options grants to have a strike price equal to or above the fair market value of the underlying company stock on the date that the option is granted

‘Success disaster’: employees run the risk of being harmed financially for building a succeeding business that has grown in value significantly

Up Round: when the pre-money valuation of a future financing is higher than the post-money valuation of the prior financing; often seen as a positive sign for the company

VC Valuation Method: a valuation methodology that entails projecting a company’s exit value in the future and a VC’s required MOIC in order to back into an implied valuation and ownership level at time of investment (starting with the future and backing into the present)

Vesting: the process of gaining ownership over granted stock options

Warrants: when issued/contracted, give the warrant holder the right to buy a certain number of shares of the company’s common or preferred stock at a predefined price over a specified period

PM + R = PO ➡️ the pre-money valuation plus the round size = the post-money valuation

PO – R = PM ➡️ the post-money valuation minus the round size = the pre-money valuation

PM / FDSO = PPS ➡️ the pre-money valuation divided by shares outstanding = price per share

R / PO = O ➡️ round size divided by the post-money valuation is the amount of ownership acquired in a financing by participating investors

D / PO = Daniel’s O ➡️ Daniel’s investment divided by the post-money valuation is the amount of ownership Daniel is acquiring in a financing

Fundraising

Rule #1: Communicate early and consistently. Goal: build long term relationships with a roster of investors before you kick off a process.

Rule #2: Ask for help. The only way to get maximal value out of your cap table is by asking for help. Especially when times are tough, great investors can potentially be the difference between make or break.

Rule #3: Keep knocking. As hard as it is, keep communicating with rejectors and make them aware of your progress.

Is there a topic you’d like us to cover? Don’t be a stranger! Ever want to dive deeper on a topic in VC Investing or Law?

We can be reached here:

Daniel Faierman ➡️ [email protected] 

Chuck Cotter ➡️ [email protected]

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✍️ Written by Daniel Faierman and Chuck Cotter 

Disclaimer: The information provided in this entry does not, and is not intended to, constitute legal or investment advice; instead, all information, content, and materials available in this entry are for general informational purposes only.