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The importance of honoring pro-rata agreements

aaronkharris.com

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Re: The importance of honoring pro-rata agreements

#11

Post by tptacek »

7Figures2Commas wrote: post #8
austenallred wrote: post #2

I'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.

Are you sure you're not moving the goalposts here, like, a lot? If you make a promise, keeping it doesn't constitute "going to bat for someone".

Re: The importance of honoring pro-rata agreements

#12

Post by 3pt14159 »

founder6564 wrote: post #3

I 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 inv…

Can you share the rough deal size and investor payback? Most investors have 1x liquidation preference, and I can totally see them getting at least that, even if they didn't write it into the contract; but if they are asking for more than 3 or 4x on a short term deal, then they're just being greedy.

Re: The importance of honoring pro-rata agreements

#13

Post by vasilipupkin »

joshu wrote: post #7
jpeg_hero wrote: post #5

laughing 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.

Theoretically, you could form special purpose vehicles with the intention to exercise your rights without putting a lot of your own money in. But yeah, I am with you, on the most successful companies, valuation ends up being too high for a seed investor anyway

Re: The importance of honoring pro-rata agreements

#14

Post by founder6564 »

3pt14159 wrote: post #12
founder6564 wrote: post #3

I 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 inv…

Can you share the rough deal size and investor payback? Most investors have 1x liquidation preference, and I can totally see them getting at least that, even if they didn't write it into the contract; but if they are asking for more than 3 or 4x on a short term deal, then they're just being greedy.

I would like to keep it confidential, since my investors likely read HN. Deal size was above 5 million but less than 10 million. They are pure common, no liquidation preference or anything like that. For all intents and purposes they hold the same shares and rights as myself.

They invested more than they would receive in a sale under pro-rata terms, so they would have a loss, but still a partial return on investment. You say I should honor terms not written into a contract and give them a 1x preference? Seems silly to me. If they wanted those terms, they should have negotiated it. I do not feel entitled to give them more than what they negotiated for. These guys are a professional fund and this is the name of the game.

Unfortunately, it looks like unless I cave they will just let the company die. They ultimately know that the sale means much more to me than it does to them. All the pressure is on me, to end up with 'fuck you' money. They likely do not care about the money as much as not having to write down a loss or something. If I was to give them what they want, I would walk away with close to nothing after having spent significant time working for almost no salary.

Re: The importance of honoring pro-rata agreements

#15

Post by chimeracoder »

tptacek wrote: post #10
austenallred wrote: post #2

I'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.

> It's pretty straightforward, as ethical dilemmas go. "Excitement" comes nowhere close to justifying breaking your word.

Agreed - this is inexcusable.

If you lose an investment because a later-stage investor is keen on you cheating existing investors out of what you already promised them, I'd say you dodged a bullet - you don't want them owning any piece of your company.

If your later-stage investors are so keen on working with investors who are willing to renege on their promises and legal obligations to earlier investors, that says something about:

(A) The types of entrepreneurs they want to work with

(B) How they themselves can expect to be treated in later rounds, when they are now the "earlier investors".

Re: The importance of honoring pro-rata agreements

#16

Post by 7Figures2Commas »

tptacek wrote: post #11
7Figures2Commas wrote: post #8

Earlier quoted context omitted.

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.

Are you sure you're not moving the goalposts here, like, a lot ? If you make a promise, keeping it doesn't constitute "going to bat for someone".

In an ideal world, everyone would honor their agreements. In the real world, the behavior Aaron is describing is happening whether we like it or not.

Angel investors who are concerned about their pro rata rights can't pretend that they exist in an ideal world. They can do one of two things: passively accept whatever they get, or take action in an effort to get what they want.

If you recognize the motivations of founders (and the pressures they may be put under), it is clear that the behavior of the angels themselves can either incentivize or disincentivize founders when it comes to honoring the obligations they made under different circumstances.

Re: The importance of honoring pro-rata agreements

#17

Post by joshu »

Pro rata is most important in the case of a down round. Your ownership really dilutes in that situation.

For what it's worth, I've definitely been asked nicely if I would consider not taking my prorata because space is needed. When things are THAT tight I am often asked to sell shares to the new investor as well.

Re: The importance of honoring pro-rata agreements

#18

Post by idlewords »

7Figures2Commas wrote: post #16
tptacek wrote: post #11

Earlier quoted context omitted.

Are you sure you're not moving the goalposts here, like, a lot ? If you make a promise, keeping it doesn't constitute "going to bat for someone".

In an ideal world, everyone would honor their agreements. In the real world, the behavior Aaron is describing is happening whether we like it or not. Angel investors who are concerned about their pro rata rights can't pretend that they exist in an ideal world. They can do one of two things: passively accept whatever they get, or take action in an effort to get what they want. If you recognize the motivations of found…

It's possible to behave ethically in a fallen world. It's not even that hard. Your pose of hard-nosed realism is actually more repugnant than just straight up saying "I'm breaking my agreements because I want to".

Re: The importance of honoring pro-rata agreements

#19

Post by not_that_noob »

This behavior of the VCs towards angels is as old as the hills. They want control and will screw with anyone who stands in their way. In fact, I have long speculated that a requirement to make partner at some firms is how smooth you are when screwing over a founder or angel.

The truth is that the smaller investors don't have leverage. And so they swallow hard and sign the paperwork. I applaud YC trying to stand up for the little guy, but I fear they will be unable to fight the seduction of founders of hotshot companies by big-name big-money VCs whispering sweet nothings into their ear.

Re: The importance of honoring pro-rata agreements

#20

Post by 7Figures2Commas »

jpeg_hero wrote: post #5

laughing 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.

Yes, the numbers are absurd. I feel sorry for LPs in any seed fund run by somebody who is handing out $10 million valuations.

As for the $1 billion exit, according to CB Insights, in 2013, 19 tech companies went public or were acquired at a billion-plus valuation. That represents slightly more than 1% of all exits. Over 70% of the exits were under $200 million. So any angel banking on billion dollar exits would probably be better off going to Vegas.

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