**Pro Rata Rights: A Valuable Asset for VCs**
Pro rata rights, which allow venture capitalists (VCs) to buy more shares in a portfolio company during subsequent funding rounds to maintain their ownership percentage, have become increasingly important in the VC industry. However, exercising these rights can be costly, especially when new lead investors in later rounds demand their preferred allocation. In some cases, new investors may even try to squeeze out pro rata investors altogether. This presents a challenge for early-stage investors and smaller funds who may struggle to participate in later rounds due to limited resources.
**Funds Supporting Pro Rata Exercise**
To address this issue, investment companies like Alpha Partners, SignalRank, and SaaS Ventures have emerged to provide capital at the Series B level and later rounds. These funds support seed-stage and Series A VCs who want to exercise their pro rata rights. By offering money to invest in their pro rata, these funds enable early-stage investors to stay involved in subsequent funding rounds.
SaaS Ventures, for example, focuses on deals led by the top 25 VC funds listed on its website. By betting on the unfair advantage of these top players, SaaS Ventures can make quick decisions without extensive due diligence. The company recently closed a new fund with $24 million in capital commitments and has already made five deals, including investments in Apollo.io, MaintainX, Cover Genius, and Elisity.
**Pro Rata Boom: A Challenging Landscape**
The demand for pro rata deals has surged in recent years, driven by a decrease in the number of deals done at later stages. In the first quarter of 2024 alone, VCs raised $9.3 billion across 100 U.S. funds, accounting for just 11.3% of the total raised in 2023. This leaves many VCs unable to fund their pro rata rights, resulting in missed opportunities.
According to Steve Brotman, managing partner at Alpha Partners, as much as 95% of the time, investors aren’t exercising their pro rata rights. This trend can be attributed to the cautious approach taken by LPs, who were burned by rushing into co-investments at high valuations in previous years. Brotman likens the situation to playing Blackjack and emphasizes the importance of doubling down on investments when the opportunity arises to yield significant returns.
**The Importance of Pro Rata for VCs**
Pro rata rights not only allow VCs to maintain their ownership percentage but also enable them to stay involved in the company and have a say in its future. By exercising their pro rata rights, VCs can often secure a seat on the company’s board, ensuring they can continue to work closely with the founders and provide valuable guidance and support. This is particularly important for early-stage VCs, as it allows them to ride the success of their unicorns and maintain a strong relationship with the CEO.
**Conclusion**
Pro rata rights have become a valuable asset for VCs, allowing them to protect their ownership and stay involved in portfolio companies during subsequent funding rounds. However, exercising these rights can be expensive and challenging, especially for early-stage investors and smaller funds. Investment companies like Alpha Partners, SignalRank, and SaaS Ventures have emerged to address this issue, providing capital to support pro rata exercise. Despite the growing demand for pro rata deals, many VCs still fail to fund their rights, missing out on potentially lucrative opportunities. To maximize returns and maintain strong relationships with founders, VCs must prioritize doubling down on their winners and actively engage in discussions about pro rata rights.