Here’s Everything You Need To Know About Pro Rata Rights

What Are Pro Rata Rights?

Pro rata rights, sometimes called proportional rights, are rules in investment deals, especially for startups. These rights let existing investors put more money into the company when it raises more funds. This way, they keep the same percentage of ownership they had before. In simple words, it helps them stay as important owners as the company grows, even when new people invest in it.

For startup investments, it means that investors can invest money in proportion to the ownership they already have. This keeps their ownership the same even as the company creates more shares or gets more money. These rights are useful for early investors because they protect their ownership and help them benefit from the company’s growth and success.

How To Calculate It?

Calculating pro rata rights involves a straightforward formula:

Pro Rata Rights = (Investor’s Ownership Percentage) x (New Investment Amount)

Let’s break this down with an example:

Suppose an investor holds a 10% ownership stake in a startup with a current valuation of $1 million. If the startup decides to raise an additional $500,000 in a new funding round, the investor’s pro rata rights would allow them to invest an additional amount to maintain their ownership percentage. In this case, the calculation would be:

Pro Rata Rights = (10%) x ($500,000) = $50,000

So, the investor would have the opportunity to invest an additional $50,000 in the new round to keep their ownership stake at 10%.

Preemptive Rights Vs Pro Rata Rights

Preemptive rights and pro rata rights are closely related concepts in the world of startup investments, but they serve slightly different purposes.

Preemptive Rights: Preemptive rights, also known as anti-dilution rights, give existing investors the option to purchase additional shares at the same price and terms as a new funding round. This helps protect their ownership percentage from dilution due to new investments. If the investor decides to exercise their preemptive rights, they can maintain or even increase their ownership stake.

Pro Rata Rights: As discussed earlier, it allows existing investors to participate in a new funding round to maintain their ownership percentage. While preemptive rights focus on preserving the ownership percentage, it enable investors to invest a proportional amount to their existing stake.

In summary, preemptive rights are more about protecting ownership percentage through additional shares, while pro rata rights ensure proportional investment to maintain the existing ownership percentage without necessarily increasing it.

Are Pro Rata Rights Included In SAFE?

A SAFE (Simple Agreement for Future Equity) is a common instrument used in startup financing. SAFE documents can include pro rata rights, providing certain protections and opportunities to investors.

Pro rata rights in a SAFE typically grant existing investors the option to participate in future equity financing rounds of the startup. This means that if the startup decides to raise additional capital through an equity financing round, investors with it under the SAFE will have the opportunity to invest an amount proportional to their existing ownership stake to maintain that stake.

SAFE agreements can vary, and not all of them include pro rata rights. The inclusion of it in SAFE is negotiable between the startup and the investor.