Pro rata is a bad term for founders
For those who aren&#x27;t familiar with Pro Rata, the term isn&#x27;t being well defined here or in the original post.<p>This site [0] does the best job explaining what Pro Rata rights are and why are they are important to both investors and their potential issues:<p>&quot;Pro-rata right is a legal term that describes the right, but not the obligation, that can be given to an investor to maintain their initial level of percentage ownership in a company during subsequent rounds of financing.<p>In other words, if an investor with a pro-rata right initially acquired a 10% equity stake in a company, then he or she is given the option to invest more in the next rounds of the company’s financing to maintain a 10% stake.<p>...<p>The idea of a pro-rata right is essentially related to the concept of dilution. Each new round of equity financing implies the issuance of new shares. When new shares are issued, the percentage of the equity stake of current shareholders (founders, investors) is diluted. In other words, the current shareholders lose part of their voting power as calculated on a percentage basis.<p>In order to prevent such a scenario, the investors can ask a company to include a provision that grants them pro-rata rights. The investor with the pro-rata right is then able to maintain the percentage of their equity stake and voting power even with the issuance of new shares.<p>Note that the pro-rata right is not an obligation, and it can be exercised at the discretion of its holder. Some investors with pro-rata rights may opt not to exercise their option to invest in the next rounds of financing. The reasons for abandoning the rights include poor performance or development of a company, as well as extremely large additional investments required to maintain the initial ownership percentage.<p>In addition, in some cases, investors do not receive pro-rata rights. Some companies opt to grant such rights to valuable investors who have made a significant impact on the business.<p>Pro-rata rights are generally granted to, or asked for by, investors who invest in early rounds of financing. The investors are often not willing to exercise their rights in the later financing stages due to the high investment amount required.&quot;<p>As per above, the option to maintain the investor&#x27;s initial equity is entirely up to the investor in subsequent rounds. However, this option is not afforded the founder. The founder is not able to maintain their ownership across rounds, because, for evident reasons, the equity that is granted to the investors necessarily comes out of the founders&#x27; shares. It has to add up to 100% (this can&#x27;t be the startup version of The Directors).<p>One way I like to visualize this is like a growing pie. Like an actual pie, perhaps apple or blueberry, or pumpkin or chocolate silk.<p>In the beginning the pie is really small and can fit in the palm of your hand. It&#x27;s all your pie that you and your founders can share. It&#x27;s so small you can probably each eat it in one or two bites.<p>Now someone else is interested in your pie and contributes money (ingredients) to increase the size of your pie. They increase the size of your pie in exchange for 1&#x2F;3 ownership. Now 1&#x2F;3 of the pie is the investors to eat, and the other 2&#x2F;3 is yours. You don&#x27;t own all the pie anymore, but you and your founders can eat your portion of the pie now in two bites each. Hey the pie has grown for everyone, even if you share is smaller, your portion is more bites than it was before.<p>Now your pie is looking pretty darn attractive and someone else wants in. So a new investor puts in even more ingredients and really increase the size of the pie. In exchange, they take 1&#x2F;3 of the pie. That shrinks your portion of the pie even further, and even that of the previous investor. The previous investor really likes your pie and they&#x27;re not content with the number of bites they had before since the pie is so much bigger. They want more bites. So they chip in along with the new investors to keep their stake at 1&#x2F;3 of the pie.<p>At this point, the founders have 1&#x2F;3 of the pie, the first investors have 1&#x2F;3, and the new investors have 1&#x2F;3. The pie is much bigger, and everyone has many bites. In the beginning the founders had the whole tiny pie to themselves, and now they have 1&#x2F;3 of a much bigger pie. They also have more people invested in the pie. It&#x27;s not entirely your decision on what happens to the pie. Just hope it keeps growing so that when you sell your pie (assuming you haven&#x27;t eaten it), it will go to someone who will buy that pie for more than the cost of the ingredients and all the time you spent on it.<p>[0] <a href="https:&#x2F;&#x2F;corporatefinanceinstitute.com&#x2F;resources&#x2F;knowledge&#x2F;finance&#x2F;pro-rata-right&#x2F;" rel="nofollow">https:&#x2F;&#x2F;corporatefinanceinstitute.com&#x2F;resources&#x2F;knowledge&#x2F;fi...</a>