Pro-rata Rights

Pro-rata rights give an investor the right to continue investing pro rata in future rounds. This allows the investor to maintain their percentage ownership in the company when new capital is added. Early investors in particular use them to secure their position in successful companies.

The economic value of this right is often underestimated: in a portfolio where a few very successful holdings carry the entire result, the ability to keep investing in precisely those cases is a central return driver, because risk at that point is far lower than at first entry. That is exactly why venture funds set aside a substantial part of their capital for follow-on investment from the outset. The right should be distinguished from the statutory subscription right available to all shareholders: pro-rata rights are agreed contractually, often granted only to investors above a minimum holding and sometimes supplemented by an additional right to subscribe beyond one's percentage. From the company's perspective they cut both ways, because they can constrain a new lead investor seeking a particular minimum stake. Term sheets therefore regularly provide for circumstances in which the right can be suspended. Linking them to a pay-to-play provision is also common, under which investors that do not participate lose certain preferential rights.

In practice the right is exercised by only some of those entitled, because participating in later rounds requires substantial amounts and many early investors have not reserved for it. Funds therefore explicitly earmark part of their capital for follow-on investments, often around half of the fund. For the company, exercise sends a signal to new investors, because a decision by existing shareholders not to follow is read as reservation about future prospects. Contractually it needs to be settled whether the right transfers on a partial sale of the holding.