Prorata rights are one of the most important rights of private market technology investors and yet are seldom fully understood. They often create the biggest tensions between investors who are investing at different stages in the business.
politics of money by bastera rusdi on 500px
These tensions seep out in some angels or seed funds publicly or semi-privately deriding later-stage VCs for their “bad” behavior. I have seen bad behavior from later-stage VCs, believe me. But I have seen equally bad behavior from super early stage investors.
As always a balanced perspective is in order. Here’s what you need to know.
1. Why investors care about prorata rights
Prorata investment rights give investors the right to invest in a startup’s future fund-raising rounds and maintain their ownership % in the company as the company grows and raises more capital. This is important for nearly every institutional investor because once you have 25-50 investments being able to “follow” the investments that are working well is critical to making money. It’s why I often advise angel investors to be careful about assuming that being an angel investor is a profitable exercise unless you have the ability to have a wide-enough portfolio to have a few companies doing extraordinarily well plus deep enough pockets to follow your winners.
For institutional money, prorata rights are compulsory and usually non-negotiable. Put simply – if you invested early in Google, Facebook, Twitter, LinkedIn, etc. would you want to give up the right to invest in subsequent private-market rounds?
2. Do investors always take up their prorata rights in later rounds?
The simple answer is “No.” Some do, some don’t.
I often talk about what I’m looking for when I meet with an entrepreneur. Above all else I’m looking for a genuine passion for what the entrepreneur is doing. It’s even a direct quote in my Twitter bio.
Of course passion isn’t enough. You need a set of innate skills that differentiate you from the thousands of others who set out on your similar journey. You need a great concept in which you will build something that is truly unique and that will be valued by your customers. But without a passion for what you do I am dubious about your chances for success.
If I had to put a number on it I’d say 1 in 20 pitches – maybe 1 in 30 – are by an entrepreneur who comes across as truly passionate about her project. You can sense when it is a “mission” for this entrepreneur to succeed and she will continue the journey even if success isn’t easy or immediate. It is in her blood to see this journey through and try to launch her product or service to the world.
Picking a VC is hard. You don’t really have much to go on to decide who would make a good fit. Reputation of firm? Of partner? Deals done in your industry? It’s a bit of all of these.
I had an enjoyable conversation this morning with a young team straight out of college this morning and they were calling to ask advice on how to approach fund raising (angels vs. VCs, how to select a VC, etc.) and I realized that without years of experience it is tough to answer this question.
So I thought I’d write about out with what I would look for in a VC knowing what I know now and why.
Most VCs are book smart. It’s insanely competitive to get into our industry so most have degrees from institutions like Stanford, Harvard, Wharton and University of Chicago (blatant plug ;-). Smart is simply not a differentiator. In fact, book smart can be a negative. The last thing you want is a know-it-all telling you what to do when they are at 50,000 and haven’t had to deal with your exact circumstances.
I call them “VCs Seagulls.” (you know … fly in, shit on you and then fly away).
If you track the venture capital industry it would be hard to miss the conversation going on this week over AngelList “Syndicates.”
From the hyperbolic Jason Calacanis weighing in that “The petty VC’s did everything to deride [Naval, the co-founder of AngelList]” as though the industry was collectively shitting its pants that AngelList was going to put us out of business. But Jason is one of the smartest thinkers in our industry so while style points in his eye-poking post might be low, he’s definitely scratching at something important.
My favorite new VC blogger, Hunter Walk, weighed in with some thoughtful comments about how Syndicates might actually pit, “angel vs. angel.”
And even the venerable Fred Wilson weighed in with how people “leading vs. following” in funding rounds play different roles and have different skills.
I sit through a lot of presentations. These range from companies pitching me to portfolio companies presenting at board meetings.
Each of these scenarios has a team presenting. Almost always the CEO plus members of his or her management team including tech, marketing, sales and/or product.
Some CEO’s are masters at communicating when team members are present. Some fare less well.
Investors love teams. They want to see a strong CEO / Leader who is in charge but they also want to see that you can lead talented people. One of the most important traits of a great leader is the ability to attract and retain high-calibre team members. Great leaders are able to empower their team members to make autonomous decisions and great leaders know when to empower them versus when to step in and course correct.
So part of seeing you with a team is to get a read on team dynamics and believe me all VCs discuss the team dynamics after you leave as in
Here are some guidelines for you – particularly for VC pitch meetings.
Last year I wrote a blog post on entrepreneurs with a chip on their shoulders.
I think it’s an important read. A chip on one’s shoulder as in, “Fuck the system, it’s broken and I want to fix it” is exactly the energy I look for in entrepreneurs.
My internal compass says that “country-club” entrepreneurs struggle to make as big of an impact because it’s really hard to totally change a system that you’re part of and have a vested interest in. It’s hard to be a rebel when upsetting the apple cart affects a bunch of people like you.
Take Maker Studios. What I loved about the founding team from day 1 was that the founders were all people who tried to break into Hollywood and found the system closed. So their view was, “fuck the system, let’s create a new one on YouTube.”
On the other hand, if the chip on your shoulder is, “I’m not treated fairly by the system, boo hoo, I’m different and that’s why you aren’t helping me” that chip can be a big negative.