The importance of honoring pro-rata agreements
aaronkharris.com
The importance of honoring pro-rata agreements
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Re: The importance of honoring pro-rata agreements
#2I've seen this a couple times where the onus is mostly on the later-stage investors. They know the terms, and they know exactly what they need to say to lock out the earlier stage investors and take over a bigger portion of the round, so they start pushing levers to see what they can get to move, playing on the FUD of the founders that they might not be able to raise from somewhere else.
What a terrible place to be put in as a company: A big opportunity you're incredibly excited about, but contingent on you screwing over the people who have helped get you to where you are in a small way.
I would encourage any founders who are put in this type of scenario to fight back hard. Investors that are worth their while will respect your loyalty and your refusal to go back on your word. If I were a later-stage investor who proposed something like that and the company came back strong saying, "That's not even on the table, because we're not going to do something below the belt" I would gain additional respect for that company.
Re: The importance of honoring pro-rata agreements
#3I am currently on the other side of the table. I have a startup that is doing well in traffic, but running out of money quickly. I want to sell the company, and I have several buyers, but my investors who have common stock are threatening to kill any deal I bring unless they get above and beyond their pro-rata shares.
At least the investors in this article have the option of not signing whatever paperwork the new investors push on them. Much harder situation for me as I risk walking away with nothing unless I give more than our investors are entitled to.
Re: The importance of honoring pro-rata agreements
#4In some cases this could be angel investors simply not doing what's in their best financial interest, either short-term or not at all.
If one gets the reputation of always giving up one's pro-rata rights, then you might as well not have them, right?
It's interesting to consider in what circumstances consenting to surrendering their pro-rata might be rational behavior.
The surrender is financially equivalent to doing the round at a lower valuation -- as angel investors have effectively sold their pro-rata rights back to the founders, who give them to the new investors. However, compared to simply doing the lower-valuation round, this approach saves more face for the angel investors.
Re: The importance of honoring pro-rata agreements
#5laughing at the default variables in the spreadsheet. ludicrous the idea that you can get a 50x return by owning a 1% of a company that was seeded at a $10m valuation.
....and lets just assume a $1B exit for arguments sake! haha, this guy must be raising money for a seed fund or something.
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oh yeah, and the fact that prorata shares actually cost you something, you don't get them for free as Aaron seems to think.
Re: The importance of honoring pro-rata agreements
#6I've seen this a couple times where the onus is mostly on the later-stage investors. They know the terms, and they know exactly what they need to say to lock out the earlier stage investors and take over a bigger portion of the round, so they start pushing levers to see what they can get to move, playing on the FUD of the founders that they might not be able to raise from somewhere else. What a terrible place to be p…
Keep in mind that unless the existing investors actually sign something agreeing to this, it cant happen. Many likely do sign, because they think that getting big-namebrand-investor onboard is worth the haircut. If they don't want to do it, they don't have to. If the company does it anyways, they would have a slam dunk legal case to reclaim their ownership. Majority shareholders diluting minority shareholders for their own benefit is probably the most common business dispute there is.
Re: The importance of honoring pro-rata agreements
#7laughing at the default variables in the spreadsheet. ludicrous the idea that you can get a 50x return by owning a 1% of a company that was seeded at a $10m valuation. ....and lets just assume a $1B exit for arguments sake! haha, this guy must be raising money for a seed fund or something. -- oh yeah, and the fact that prorata shares actually cost you something, you don't get them for free as Aaron seems to think.
Indeed.
I often pass on my prorata simply because it would be too expensive to keep up with, and it would mean not investing in new companies. Since that's the fun part, I am happy to do that instead.
Re: The importance of honoring pro-rata agreements
#8I've seen this a couple times where the onus is mostly on the later-stage investors. They know the terms, and they know exactly what they need to say to lock out the earlier stage investors and take over a bigger portion of the round, so they start pushing levers to see what they can get to move, playing on the FUD of the founders that they might not be able to raise from somewhere else. What a terrible place to be p…
Founders realistically have to pick and choose their battles. If a founder raises a seed round from 10 investors who each invest a five figure amount, and eight of those 10 investors do little to nothing after writing a check, it's difficult to expect the founder to go to bat for them if push comes to shove.
Re: The importance of honoring pro-rata agreements
#9In some cases this could be angel investors simply not doing what's in their best financial interest, either short-term or not at all. If one gets the reputation of always giving up one's pro-rata rights, then you might as well not have them, right? It's interesting to consider in what circumstances consenting to surrendering their pro-rata might be rational behavior. The surrender is financially equivalent to doing…
This is somewhere between wrong and irrelevant.
Re: The importance of honoring pro-rata agreements
#10I've seen this a couple times where the onus is mostly on the later-stage investors. They know the terms, and they know exactly what they need to say to lock out the earlier stage investors and take over a bigger portion of the round, so they start pushing levers to see what they can get to move, playing on the FUD of the founders that they might not be able to raise from somewhere else. What a terrible place to be p…
I'm not sure this is such a terrible place for founders to be put in. It's pretty straightforward, as ethical dilemmas go. "Excitement" comes nowhere close to justifying breaking your word.