Seedspace

Term sheet

Pro rata rights

A right for an existing investor to buy into the next round to keep their percentage. Useful to investors, and a real cost to founders if handed out freely.

Reviewed Applies to: United States 3 min read Sources

A pro rata right (also called a participation or preemptive right) lets an existing investor buy part of a future round, usually enough to keep its percentage ownership. For investors it is valuable: it lets them put more money into the companies that turn out best. For founders it is a commitment to make room in the next round, and that room has to come from somewhere: either the new lead takes less, or the round gets bigger and dilutes everyone more.

In priced rounds

After a priced round, pro rata rights normally sit in the investors' rights agreement and are given to "major investors" above a threshold set in the term sheet. The right is usually to buy a share of new securities equal to the investor's fully diluted ownership, with exceptions for routine issuances (employee options, conversions, acquisitions). Some agreements let investors take up the unused allocation of others ("over-allotment").

With post-money SAFEs: the side letter

YC's post-money SAFE has no pro rata right of its own. Instead YC publishes an optional pro rata side letter that gives the SAFE holder the right to buy into the priced round in which the SAFE converts (typically the Series A), up to its as-converted ownership. The guide is explicit that this is a choice to make deliberately: "please consider this pro rata right carefully", because at the Series A the company has to fit in the new investors, the SAFE holders with side letters, and anyone else it wants to include.

Estimating what it will cost

YC's guide gives a formula to estimate the extra stake the Series A must sell if SAFE holders with side letters take up their pro rata, given the percentage new investors want for themselves:

pro rata allocation % = new investors % ÷ (100% − safes with pro rata %) − new investors %

Worked example (from YC's guide). SAFEs worth 15% of the company all carry side letters; the Series A lead and other new investors want 25% after the round; the round also tops up the pool to 10%.

  1. Pro rata allocation = 25% ÷ (100% − 15%) − 25% = 4.41%.
  2. Total Series A money = 25% + 4.41% = 29.41% of the company; with the 10% pool, the round dilutes existing holders by 39.41%.
  3. The SAFEs' 15% is diluted to 15% × (1 − 39.41%) = 9.09% before their pro rata purchase.

Without side letters, the round would sell 25% plus the pool; with them, it sells 4.41 points more, and that comes from the founders and other holders. Our engine reproduces this example (validation).

YC's guide also inverts the formula to set a limit: if the founders want the Series A money to be no more than a target percentage, the share of SAFEs that can carry pro rata rights is 100% − (new investors % ÷ total round %). For example, with 25% wanted by new investors and a 28% ceiling, SAFEs worth at most 10.7% of the company should get side letters.

Ways to hand them out

  • Minimum check size. Pro rata only for investors above a threshold. Common in priced rounds and simple to administer, with fewer people to coordinate at closing.
  • Everyone. Least negotiation now, possibly more pain later: the Series A lead may push back on a long list of pro rata holders.
  • A budget. Decide what extra dilution you can accept at the Series A and back-solve how many SAFEs can carry the right, using the formula above.

What to watch

  • Which round the right applies to: the converting round (YC side letter) or later rounds (investors' rights agreement).
  • Whether the right is to maintain ownership (pro rata) or a fixed amount, and whether it includes over-allotment.
  • The major-investor threshold, and whether it is in dollars or shares.
  • The notice and response period, and whether the lead can cut back pro rata allocations ("super pro rata" rights for one investor are a red flag for other investors).

Sources

  1. Post-Money Safe User Guide, Y Combinator. Cited for facts; not reproduced.
  2. SAFE financing documents (post-money SAFE forms and pro rata side letter), Y Combinator. Cited for facts; forms are CC BY-ND 4.0 and not reproduced.
  3. Model Legal Documents (term sheet, certificate of incorporation, investors' rights, voting and ROFR/co-sale agreements), National Venture Capital Association. Cited for structure; not reproduced.

Read next

Instrument The post-money SAFE The standard instrument for early rounds in the U.S. Its cap is a post-money valuation, so the ownership you sell is simply the amount divided by the cap. Calculator Cap table and dilution simulator Add your SAFEs and notes, set the round, and see the price per share, each investor's conversion and the cap table after the round. Stage Series A Usually the first priced round led by an institutional investor. It converts the earlier SAFEs and notes and sets the governance the company will live with.