What You Need to Know About Pro Rata
A Thought Leadership article we liked from Propel(x):
What is pro rata and why does it matter when investing in startups?
For a so-called dead language, Latin still manages to pop up frequently in the modern day, especially in the legal and financial world.
The term “pro rata” is Latin, and it is simply a fancy way to say, “in proportion”.
Pro rata is the benefit you receive from something that you do or something you own will be in proportion to your share of the whole. For example, if you work part-time four days per week, then your salary would be paid on a pro rata basis of 80% of the full-time wage. Or, if you own 5% of a company and that company paid a dividend totaling $100,000, then your dividend would be paid on a pro rata basis of 5% x $100,000 = $5,000.
What are pro rata investment rights?
Pro rata investment rights give an investor the right (but not the obligation) to invest in future funding rounds, so they can maintain their percentage ownership of the company.
A pro rata investment right gives an investor the opportunity to prevent their ownership from being diluted when new investments are made.
Dilution of shareholding
It is important to understand the concept of dilution because this can have a major impact on your ownership stake. A shareholder owns a portion of a company based on how many shares they own compared to the total number of issued shares. But as additional funding rounds occur, more shares may be issued and if the shareholder does not continue to purchase more shares, then their percentage of ownership will be diluted.
For example, if a startup issued 10m shares and a seed investor purchased 2m shares, they would own 20% of the company. But if an additional 10m shares were issued by the company in future capital raises, and the seed investor did not buy any more shares, then their percentage ownership of the company would be diluted and would drop down to 10% (their original 2m shares out of the new total of 20m shares).
Check out this post if you’d like to learn more about dilution.
Why is pro rata important?
Pro rata investment rights are important because of the nature of Venture Capital (VC) and how investors potentially make their returns. The unfortunate reality in startup investing is that many companies fail, and many investors lose all of the money invested. . So, the way to potentially achieve good returns in VC is to double down on the successful companies, through your pro rata rights.
The big VC investors are the ones who usually receive pro rata rights. So, if one of their companies is doing well, they will continue to invest and stay in for subsequent funding rounds.
Platforms like Propel(x) work hard to secure pro-rata rights for our investors. If you have invested in a syndicate via Propel(x), please look out for portfolio updates from Propel(x) and be on the watch for these opportunities — such opportunities are often filled out rapidly.
Pro rata example
Let us work through a hypothetical example to illustrate how pro rata investment rights can potentially work in a startup investment scenario. Let us say there were two seed investors; one with experience who negotiated hard and successfully got pro rata rights into her term sheet, and the other a novice whose term sheet did not include pro rata rights. And let us say this startup knocks it out of the park with multiple funding rounds and a highly profitable exit. To keep it simple and illustrate the point, we will assume that...
Read the rest of this article at medium.com...
Thanks for this article excerpt and its graphics to Propel(x).
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