Pro rata is a bad term for founders • Hacker News Board

Re: Pro rata is a bad term for founders

#21

Post by Stratoscope » Tue, Oct 12, 2021, 12:46 AM UTC

aeternum wrote: post #18

It'd be really nice if articles like this began with a definition of the term. Terms can often be ambiguous so this helps ground the article and ensure everyone is talking about the same thing. There are also plenty of HN readers who have no idea what it refers to that would also benefit greatly.

I'm one of those HN readers who has no idea. All I knew about "pro rata" was from tire warranties!

http://continentaltire.custhelp.com/app/answers/detail/a_id/...

robotresearcher linked to an investment-related definition in another comment:

https://corporatefinanceinstitute.com/resources/knowledge/fi...

Re: Pro rata is a bad term for founders

#22

Post by mchusma » Tue, Oct 12, 2021, 1:28 AM UTC

Honestly I'm a founder not investor, but one of the reasons that prices are so high is because of terms. Would I invest in a public company that may be overvalued (say Tesla) if I could get preferred shares, liquidation preferences, pro rata, etc? Yes.

So pro rata is just one in a basket of investor friendly terms.

Re: Pro rata is a bad term for founders

#23

Post by thinkingkong » Tue, Oct 12, 2021, 1:34 AM UTC

jamiequint wrote: post #16

I don't agree with this, pro-rata rights protect investors from dilutionary events which they have no control over. I guess that's one-sided in the way that any "right" is in a legal contract, but that's a weird way to frame it. It's also incorrect to frame the option as "free", you're only observing market behavior in a world in which the option exists, not one in which it doesn't exist. You can't say that investors…

I agree but then circumstances to defend against are pretty limited. Effectively a situation where a founder with control issues new shares at an arbitrarily low price to a new set of individuals. There has to be a more elegant tool to defend against that kind of event.

Re: Pro rata is a bad term for founders

#24

Post by irjustin » Tue, Oct 12, 2021, 2:18 AM UTC

Hrm, overall I still lean toward pro rata being a net positive. The two situations this is advice is handling are these:

> I insisted on getting pro rata in tight rounds where the founder wanted to bring in new investors or limit dilution.

> I learned this through rough conversations with founders who expected a pro rata investment during a difficult fundraise and didn’t get it.

The 2nd situation isn't really something to protect against. To expect pro rata during a difficult fundraise is weird because the expectation is to be able to force someone to invest in your dying company? A non-situation to me.

The 1st one is the most realistic and understandable. Hot rounds really become a fight of letting the right people in at the right price. Without pro-rata small guys would disproportionately not be able to continue their investment.

So then it becomes negotiating with the incoming round's lead to lower post-money to avoid overall dilution.

Which, is always a welcomed problem.

Re: Pro rata is a bad term for founders

#25

Post by jollybean » Tue, Oct 12, 2021, 2:19 AM UTC

It's true that a pro-rata has material value.

But the author doesn't indicate how that can be problematic.

How do existing requirement to allow previous investors in the round, contribute to a 'warping' or 'problems'?

I mean, if pro-rata is only designed to prevent dilution - well that should not be so bad. That means in any given new round, there should be enough room for new investors, no?

It also should be less painful in early rounds when investors own a smaller amount.

Would it possible to do 'partial pro-rata'?

Re: Pro rata is a bad term for founders

#26

Post by jollybean » Tue, Oct 12, 2021, 2:25 AM UTC

irjustin wrote: post #24

Hrm, overall I still lean toward pro rata being a net positive. The two situations this is advice is handling are these: > I insisted on getting pro rata in tight rounds where the founder wanted to bring in new investors or limit dilution. > I learned this through rough conversations with founders who expected a pro rata investment during a difficult fundraise and didn’t get it. The 2nd situation isn't really somethi…

That's not a positive.

Giving the previous investors an option to be in/out doesn't get anything for the founder.

If they 'want in' well, then they 'want in' and presumably, they'd 'want in' with or without the pro-rata.

What this means is that their position is guaranteed. If they 'wanted in' without the pro-rate, then the founder has more leverage.

Imagine you were trading options. Someone giving away options for free doesn't gain anything. The receiver of the options gains some material value, just in the option even if the strike price was the same as the current value i.e. options even.

You'd never just arbitrarily give away options on your company.

Now - there might be something to be gained in the relationship. It might just work out better with a fund, etc. to have that on the table.

But technically, no.

What would be interesting here is for someone to chime in on what the value of that option would be were it to be sold on the free market because we have methods for calculating those things.

Re: Pro rata is a bad term for founders

#27

Post by birken » Tue, Oct 12, 2021, 2:35 AM UTC

nikhizzle wrote: post #15

One thing not mentioned here is that for very tiny investors, pro rata is a right that can protect against aggression from later, more highly resourced funders. If the company is scaling quickly, and looks like it could have a good return, a later stage investor could come in and cause massive dilution in the cap table by issuing many shares and granting some amount to the employees and founders. If I had pro rata, I…

This is a ridiculous situation. Why would you possibly plow more money into a company that is actively adversarial against you?

If a company tries to screw you like this, you have shareholder rights. If you are a big enough fish that you are getting into crazy financing battles like this, then you are not the target audience for this post.

Re: Pro rata is a bad term for founders

#28

Post by thoughtstheseus » Tue, Oct 12, 2021, 3:29 AM UTC

thinkingkong wrote: post #23

jamiequint wrote: post #16

I don't agree with this, pro-rata rights protect investors from dilutionary events which they have no control over. I guess that's one-sided in the way that any "right" is in a legal contract, but that's a weird way to frame it. It's also incorrect to frame the option as "free", you're only observing market behavior in a world in which the option exists, not one in which it doesn't exist. You can't say that investors…

I agree but then circumstances to defend against are pretty limited. Effectively a situation where a founder with control issues new shares at an arbitrarily low price to a new set of individuals. There has to be a more elegant tool to defend against that kind of event.

Not really. Simple basic company structures are preferred when possible. Hot stocks get funding regardless.

Re: Pro rata is a bad term for founders

#29

Post by opportune » Tue, Oct 12, 2021, 3:41 AM UTC

nikhizzle wrote: post #15

One thing not mentioned here is that for very tiny investors, pro rata is a right that can protect against aggression from later, more highly resourced funders. If the company is scaling quickly, and looks like it could have a good return, a later stage investor could come in and cause massive dilution in the cap table by issuing many shares and granting some amount to the employees and founders. If I had pro rata, I…

I was thinking of this myself. What protects against this except for pro-rata? I am a relatively ignorant bystander to the workings of VC but even I’ve heard it’s possible for dilution (and other adverse outcomes)to be counteracted for certain recipients by issuing new shares. Basically without pro rata and board control it seems you can “reset” the cap table at will?

Re: Pro rata is a bad term for founders

#30

Post by joshu » Tue, Oct 12, 2021, 4:10 AM UTC

so, he thinks you should have to buy pro-rata, and then have the later investors take it away anyway? and then the investor is expected to go to court over it? how long do you think investors that sue their founders will continue to get good deals?

yes, pro-rata is a bit of a pain on up rounds, especially in terms of letting later investors get the ownership they want. but on a down round, previous investors get wiped out very aggressively; they need the protection to be able to at least maintain their stake.

(personally, i will typically go with whatever the founder wants. "it looks bad if you don't take your prorata" or "i can't get enough room for the new investor" and so on. if a new investors adds terms to strip previous investors of their rights, i will insist on it, though.)