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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

#31

Post by pbreit »

vasilipupkin wrote: post #13
joshu wrote: post #7

Earlier quoted context omitted.

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

Maybe pro-rata would be more palatable if it was not assignable? It makes sense to me that early investors get a shot in later rounds. Whether they should be able to maintain percentages is a different topic. Without ability to assign, I suspect many might not maintain percentage anyway.

Re: The importance of honoring pro-rata agreements

#32

Post by pbreit »

avemuri wrote: post #30

Forgive me if this is a naive question, but why are pro-rata rights considered standard? It seems like it's essentially the right to dilute founders in the future to maintain your ownership. Yes you're investing early, but that's priced into the valuation. I suppose the right has value, so perhaps a lower valuation would be justified. But why do pro-rata rights always elicit this moral outrage when called into questi…

If the pro-rata rights exist, it's seems obvious that trying to void them is at least unethical.

But pro-rata rights make perfect sense to me. I don't see it as "the right to dilute founders" but more "thanks for taking a risk on us when it was far from clear that things might work out...I know your economics necessitate a follow on like this".

Re: The importance of honoring pro-rata agreements

#33

Post by patio11 »

avemuri wrote: post #30

Forgive me if this is a naive question, but why are pro-rata rights considered standard? It seems like it's essentially the right to dilute founders in the future to maintain your ownership. Yes you're investing early, but that's priced into the valuation. I suppose the right has value, so perhaps a lower valuation would be justified. But why do pro-rata rights always elicit this moral outrage when called into questi…

You're conflating two very different sources of moral outrage. One is that, prior to investors and founders memorializing their agreement on pro-rata rights in a contract, some investors feel like they're entitled to them because they're a standard term. One reason why they're standard is detailed below.

The present controversy is that after investors/founders committed to pro-rata rights, later investors convinced founders to not honor those pre-existing commitments.

Yes you're investing early, but that's priced into the valuation.

Many investors would say "If you're investing and not getting pro-rata rights, the valuation you've negotiated is not a meaningful number, because it can be retroactively renegotiated by parties who do not necessarily have to include you in that conversation. It is thus not conveniently possible to award investors with, nor desirable for investors to seek, an attractive valuation for taking on extra risk by investing early unless that attractive valuation comes with pro-rata rights."

Re: The importance of honoring pro-rata agreements

#34

Post by danielweber »

avemuri wrote: post #30

Forgive me if this is a naive question, but why are pro-rata rights considered standard? It seems like it's essentially the right to dilute founders in the future to maintain your ownership. Yes you're investing early, but that's priced into the valuation. I suppose the right has value, so perhaps a lower valuation would be justified. But why do pro-rata rights always elicit this moral outrage when called into questi…

The angel has little power against later VC rounds besides the protections he negotiated for upfront. Since it's purely in the VC's interest to screw the angel, the angels make it a standard to negotiate this protection. And of course people get upset when a negotiated protection is tossed aside.

Re: The importance of honoring pro-rata agreements

#35

Post by [deleted] »

avemuri wrote: post #30

Forgive me if this is a naive question, but why are pro-rata rights considered standard? It seems like it's essentially the right to dilute founders in the future to maintain your ownership. Yes you're investing early, but that's priced into the valuation. I suppose the right has value, so perhaps a lower valuation would be justified. But why do pro-rata rights always elicit this moral outrage when called into questi…

[deleted]

Re: The importance of honoring pro-rata agreements

#36

Post by nasmorn »

Let us give the super angels the benefit of the doubt. They probably know that their pro-rata rights are not always enforceable and price this into the valuation. Good for them if they can keep them but they are probably at all surprised if they don't. It is a numbers game for investors.

Re: The importance of honoring pro-rata agreements

#37

Post by danielweber »

spinlock wrote: post #25

Why would a fund want to participate in a series A with an entrepreneur who screws their investors? Wouldn't the logical conclusion be to screw the series A investors when they go to raise a series B?

Because the series A investors have clout and standing with (and may be the same parties as) the series B investors.

Re: The importance of honoring pro-rata agreements

#38

Post by hglaser »

joshu wrote: post #17

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.

What do you say in those situations?

Re: The importance of honoring pro-rata agreements

#39

Post by whiddershins »

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.

I wonder how straightforward an ethical dilema it is. When signing a contract, are you ethically obligated to follow the terms of the contract, or are you merely agreeing to something which can be enforced by the terms of the contract, including penalties and lawsuits. Most people do business in the latter way: a contract is only as good as the "teeth" that make it unprofitable to violate it.
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