Should a start-up company offer each investor the pro-rata right to purchase shares issued in the future? thanks!
During a series A round, what is the standard practice for Right of First Offer?
Answers
From my experience, this is usually pretty standard practice. Before a Series B or any other follow-on rounds, the new investors will want to understand who will and who will not exercise that right...because it can make a huge difference in their ability to accomplish their objectives as the newest member of the cap table.
Ken is right - this is typical and is usually required by Series A investors. If it is not demanded, you don't have to offer it, however. Typically the investor will offer a term sheet and that is where the negotiations begin. Depending on the value that the investor adds and their ability to participate in future financing rounds, you may want them to be involved as it sends a positive message to new investors in subsequent rounds when existing investors are willing to participate and invest more in the company.
Kent, thanks for adding such a valid point--that follow-on investments from earlier rounds are often a positive sign to new investors. Great to connect with you here!
Whether it is required or not, I advise giving all existing shareholders the opportunity to participate in the next round. Apart from the fact that their money may be a significant contribution to next round funding, the invitation to participate removes any possible objections they may subsequently have regarding the terms of the next round, regardless of whether they participate.
In the absence of such an invitation they have potential grounds for arguing that the terms of the next round are unfair and not in the interests of current (or minority ) shareholders.
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Simon, I think you add a great point. Giving investors the option to be involved in future rounds, whether their stock legally gives them the right, is almost always the best thing to do.
As early stage investors, we make this pretty standard. Some investors may not ask for it, and it they do not ask for it, do not offer. Fundraising is a negotiated exercise depending on a whole host of factors including experience of the team in raising capital.
I agree with the group that this is pretty much SOP nowadays in the funding community and I think its better than right of first refusal which can sometimes turn off new investors coming in with an offer if the existing investors have the right to match it. Kent is spot on too about optics and having the support of your current investors in any subsequent rounds.
The one place where it is less common to see is in seed/angel investors who may not have the capital/infrastructure/interest to get involved in later, larger rounds, so they'd be less likely to insist on it.
Other than that, mirroring the above, your preference for an A-round investor is someone who you want to have, and can participate, in your B and further rounds (and even the small VCs plan their funds around this expectation). This makes the pro-rata right pretty vanilla, and beneficial to both parties.
There is a difference between pro-rata rights, ROFR rights and ROFO rights, and these should not be confused. ROFO (aka Right of first Negotiation) is a pretty big give; it means that instead of going out and testing the market, you're first negotiating (typically exclusively) with your current investors. While tactically, this might be a good approach, being locked in contractually can limit your options. Pro-Rata only means that if someone else comes in, sets a price, etc, your prior investors can avoid dilution. Comparitively, ROFO can have a more significant impact on your residual % and the rights you cede.
Looping back...do you offer it? No. Let them ask for what *they* want; there's no reason to give something that may cost you, if they don't value it.
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