Seed VCs are turning to new ‘pro rata’ funds that help them compete with the big firms

Lee Edwards, partner at Root VC, has a saying at his firm that “pro rata rights are earned, not given.” That may be a bit of a stretch since pro rata refers to a term that VCs put in their term sheets that gives them the right to buy more shares in a portfolio company during consequent funding rounds to maintain an ownership percentage and avoid dilution. Still, while these rights are not exactly “earned,” they can be expensive. One of the latest trends in VC investing these days are funds dedicated to helping seed VCs exercise their pro rata rights. The problem is that in later rounds, the new lead investor will usually get its preferred allocation. Meanwhile, other new investors try to get what they can while existing investors have to pony up whatever the lead has agreed to pay per share if they want to exercise their pro rata rights. And, often, the new investors would prefer to squeeze pro rata investors out of the round altogether and take more for themselves. Meanwhile, founders want to cap the total chunk of their company they will sell in the round. “It’s pretty common that a downstream investor will want to take as much of the round as they want, and will sometimes tell the founder they need an allocation that’s so large, it wouldn’t leave room for pro rata rights — essentially telling the founder to ask earlier investors if they would willingly waive their pro rata rights,” Edwards told TechCrunch. Earlier investors often have to rely on the founder “going to bat for us and pushing back on that request,” which will only happen if the investors provide enough value that they feel comfortable negotiating on the earlier investors’ behalf, he said.