Lee Edwards, a partner at Root VC, says that at his firm, “pro rata rights aren’t given, they’re earned.” That might be a bit of a stretch, because pro rata refers to terms that VCs put into their term sheets that give them the right to buy more shares of their portfolio companies in subsequent funding rounds in order to maintain their percentage of ownership and avoid dilution.
Still, these rights can be costly, as they're not exactly something you can “earn.”One of the hottest trends in VC investing these days is funds dedicated to helping seed VCs exercise pro rata rights.
The problem is that in later rounds, the new lead investor usually gets the preferential allocation, while other new investors try to get as much as they can, but existing investors have to pay what the lead agreed to pay per share if they want to exercise their pro rata rights.
And often new investors prefer to shut pro rata investors out of the round entirely and get more money for themselves, while founders want to limit the total amount of their company's stock they sell in the round.
“It's common for downstream investors to want to get as much money as they want in a round, and sometimes they'll tell founders that their allocation is too large and they won't have any pro rata rights left — so they'll tell founders to ask their earlier investors if they want to waive their pro rata rights,” Edwards told TechCrunch.
Early investors often have to rely on founders to “fight for us and resist their demands,” but that only happens if the founders provide enough value that they feel comfortable negotiating on the early investors' behalf, he said.
Secure funds to continue playing the game
Venture capitalists may choose not to exercise their pro rata rights. While they may rightly refrain from buying more stock in struggling start-ups, lack of funds often forces them to forgo buying more stock in successful companies as well.
For example, during the venture capital investment frenzy of 2020-2022, Edwards saw many early-stage funds refusing to take pro rata cuts on later-stage rounds due to so-called “eye-watering valuations.”
Jesse Bloom, Partner at SaaS Ventures. Image courtesy of SaaS Ventures /
In fact, new investors in later rounds often run larger funds than seed investors and pay more per share, making it difficult for earlier stage investors and smaller funds to continue participating in later rounds.
This is where investment firms like Alpha Partners, SignalRank, and now SaaS Ventures come in. All three of these firms support seed-stage and Series A VCs who want to put capital into rounds at the Series B level and beyond, exercising their pro rata rights.
“For example, if Sequoia invests in Series A, other existing investors can participate,” Jesse Bloom, partner at SaaS Ventures, told TechCrunch. “But if you want to participate in Series B, you have to be invited by Sequoia, a founder, or someone involved in Series A. My job is to hear from my network that there's a Series B investment, find Series A investors, and offer to invest on their pro rata basis. I give them money to invest pro rata, and I take 10% of the carried interest.”
Most of the firms on Bloom's list of the top venture capital firms whose late-stage deals we monitor are familiar names, such as Andreessen Horowitz, Insight Partners and Valor Equity Partners.
He also said that when a deal is led by a top venture capital fund, it doesn't need to do as much vetting and so decisions can be made faster. “That's the only way I can get in. I'm betting on the unfair advantage of the top venture capital funds.”
Bloom said this is another reason why he only invests in deals led by the top 25 venture capital funds listed on his website. “In late-stage venture capital, we believe that access is more important than discretion in the long run, so we'll do anything to get access to deals led by the top funds, even if we don't know much about the companies,” he said.
Bloom had previously worked at Alpha Partners before being tapped by SaaS Ventures leaders Colin Gutman, Brian Geister and Seth Schuldiner to raise a fund to compete with Alpha.
He is now forming SaaS Ventures, a new fund with $24 million in capital commitments for these investment opportunities. The new fund is led by Pennington Partners, a multi-family office firm, as a limited partnership, and is backed by registered investment advisors who understand the benefits of larger venture capital firms but often can't participate in larger investments, Bloom said.
Bloom has already completed five transactions, including Apollo.io's Series D and MaintainX's Series C, both led by Bain Capital Ventures, Cover Genius' Series E, led by Spark Capital, and Elisity's Series B round, led by Insight Partners.
Proportional Boom
Bloom isn't the only one having success with pro rata funds. Keith Tier's SignalRank is eyeing a $33 million fund that launched in January, according to an SEC filing. Alpha is also launching a new pro rata fund, according to Steve Brotman, managing partner at Alpha Partners. The firm has secured capital commitments of just over $125 million and expects to close at the end of July with more than $150 million.
Many of the early investors on a company's cap table write checks of $1 million to $3 million, so pro rata has traditionally been the only way to participate in these larger deals, Bloom said. Likewise, for founders, this type of deal also means backing existing investors.
“Because we're essentially an LP for existing investors, they have pro rata anti-dilution rights,” he said. “At some point, founders are going to get rid of their existing investors, so I give them access to very cheap, quick capital.”
As Root VC's Edwards noted, two years ago investors weren't in a rush to do pro rata deals. But that seems to be different today: Pro rata deals are heating up, according to Bloom and Brotman, and that's mainly due to fewer later-stage deals happening, making those larger deals harder to access.
In the first quarter of 2024, VCs raised $9.3 billion through the 100 largest funds in the U.S., just 11.3% of the $81.8 billion raised in the market in 2023, according to the PitchBook-NVCA Venture Monitor.
Steve Brotman, Managing Partner at Alpha Partners Image courtesy of Alpha Partners /
Investors say this has led to an unusually large number of venture capital firms being unable to fund pro rata rights. In fact, Brotman said, investors don't exercise pro rata rights in as many as 95% of cases.
“Pro-rata rights funds and opportunity funds really boomed in 2021 and 2022, but started to trend downwards in 2023,” he told TechCrunch. “In 2024, there's very little capital being raised by smaller funds. LPs understand this. They did a lot of co-investments in 2022 and 2021 that, frankly, screwed up because they rushed in at huge valuations.”
He likened it to the card game blackjack, explaining that you can double your bet if you have a certain hand, depending on what the dealer is showing. “If you don't double when you can, the house wins. The same thing is true in venture capital, but no one talks about it,” he told TechCrunch.
Jason Calacanis, founder and CEO of Inside.com and Launch, a well-known angel investor, spoke with Brotman on his podcast “Driving Alpha” in May and said that if Brotman had used pro rata follow-on rights with his first fund, he could have tripled his revenue after already achieving 5x returns. So why didn't he?
“Well, back then, you were taking 100 swings — 109 swings in this $10 million case — and trying to hit one outlier based on a power law,” Calacanis said. In this case, the “power law” is when one investment produces a greater return than all the other investments combined.
Among institutional investors and family offices, risk and time horizons are now at play, with time horizons “really killing it,” Brotman said. Many of these institutions don't have 10 to 15 years to prove their worth, they only have around three to six years, he said.
VCs need to double down on winners and communicate to founders why it's important to do so. Pro rata rights also often mean they can stay on the board, which is important for early venture capitalists, Brotman said.
“A big part of being a venture capitalist is getting to ride your own unicorn,” he says. “Even if they're not on the board, the fact that they're investing means the CEO is going to spend more time with them and take their calls.”