by Scott Edward Walker on June 9th, 2019


Over the past few weeks, two of my clients have received financing term sheets in which the investors requested super pro-rata rights.  Accordingly, I thought it would be helpful for founders to discuss these rights and to point out the problems they create for startups.

Pro-Rata Rights

First let’s discuss pro-rata rights (sometimes referred to as “participation” or “preemptive” or “right of first offer/refusal” rights) – which investors will typically request in connection with any venture capital financing.  Simply put, pro-rata rights permit the investor to maintain its percentage ownership in subsequent financing rounds.  For example, if an investor owns 20% of the equity of a startup on a fully-diluted basis following the closing of a Series A round, it will have the right to purchase 20% of the shares of the preferred stock issued in the subsequent Series B round. 

Pro-rata rights are relatively standard and non-controversial; however, founders should try to limit such rights solely to “Major Investors” (which is typically defined to include only those investors that will own a substantial number of shares – e.g., a lead investor).  The language in a VC term sheet relating to pro-rata rights is typically akin to the following:

All [Major] Investors shall have a pro-rata right, based on their percentage equity ownership in the Company (assuming the conversion of all outstanding Preferred Stock into Common Stock and the exercise of all options outstanding under the Company’s stock plans), to participate in subsequent issuances of equity securities of the Company (excluding those issuances listed at the end of the “Anti-dilution Provisions” section of this Term Sheet).  In addition, should any [Major] Investor choose not to purchase its full pro-rata share, the remaining [Major] Investors shall have the right to purchase the remaining pro-rata shares.

Super Pro-Rata Rights

Sometimes investors are not happy with just pro-rata rights and request “super” pro-rata rights – which provide them with some percentage (or multiple) beyond their pro-rata share.  For example, an investor that will own 20% of the equity on a fully-diluted basis following the closing of a Series A round requests the right to purchase up to 50% of the subsequent Series B round.  This is a huge red flag and founders should push back very hard.    

Indeed, as Mark Suster, a prominent VC, wrote in his post “Why Super Pro-rata Rights are Not a Good Deal for Entrepreneurs”: “[I]f you’re reasonably successful such that the [investor] with super pro-rata rights wants to take his 50% of your new round…, then there might not be enough for a new outside investor to feel motivated to write you a check.”  Mark also points out that there will be a significant negative signal to outside investors if the super pro rata rights are not exercised by the inside investor.

Here is an example of a provision in a term sheet relating to super pro-rata rights:

Investors holding at least $1,000,000 worth of Series Seed Preferred Stock (each, a “Major Investor”) shall have a Super Pro-Rata Right (as defined below), but not an obligation, to participate in subsequent financings of the Company, other than the issuance of the Carve-Out Stock or the issuance and sale of Series Seed Preferred Stock pursuant to the Series Seed Stock Purchase Agreement.  Such right shall not apply to any public offering and will terminate immediately prior to a Qualified Public Offering.

“Super Pro-Rata Right” means a right of first offer to purchase up to 50% of the total amount of the next round raised in the aggregate of any Equity Securities (as defined below) the Company may sell or issue following the date of this Term Sheet. The Company shall promptly provide written notice to the Major Investors following its receipt of any offer of financing, and the Major Investors shall have seven business days in which to notify the Company if it exercises its respective Super Pro-Rata Right.

In short, super pro-rata rights are another example of investors trying to take advantage of inexperienced founders.  I liken them to participating preferred rights — which founders also often do not understand until it is too late.

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