The Pro-Rata Participation Right

I’ve touched on this subject before. It is one the “three things you must have in a venture investment“.

The “pro-rata right” is the right to continue to participate in future rounds so that you can maintain your ownership. Let’s make it concrete with an example. You invest $50k in a seed round at a $5mm cap and own 1% of the company. The next round is a $3mm round at $9mm pre, $12mm post. If you don’t participate, you will be diluted 25% and will then own 0.75% of the company. On the other hand, if you buy 1% of the round, a $30k investment, you will continue to own 1% of the company. Your “pro-rata right” in this situation is a $30k allocation in the next round.

I think this is the single most important term anyone can negotiate for in a venture capital investment. The other two in the post I linked to above are the liquidation preference, which helps on the downside but not the upside, and the right to a board seat, which is important to some investors (USV is one of them) but not to all of them. The pro-rata right helps on the upside, which is where you make all of your money in venture deals, and should be important to all investors.

The pro-rata right is something that is not typically offered in a note with cap structure in seed deals. When The Gotham Gal started investing in these kind of deals we had a long talk about it. I was negative on notes and she was positive on them. She convinced me that notes with reasonable caps are OK, but I convinced her to negotiate for a pro-rata right. She gets that on all of her deals because she walks without it. And that is just one of the many reasons I love The Gotham Gal.

I was discussing a Series A round with some founders yesterday. We talked about what they should do with their seed investors. I encouraged them to offer the seed investors the right to participate in the round. I don’t know if their seed investors have the right or not. But regardless, I feel that the founders owe it to them because their seed investors were there for them before anyone else. It just feels like the right thing to do to me.

The meta point I have come to understand about early stage investing is that a small portion of your investments produce all of the returns. In those investments, you want to own as much as you can. It’s hard to own more than your initial stake, particularly as an angel investor. But it should not be hard to maintain your initial stake. You should reserve funds to do this, you should negotiate for a pro-rata right, and you should exercise your pro-rata right when you feel like the investment is doing well.

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Comments (Archived):

  1. awaldstein

    Words to the wise Fred.Bore repeating and repeating again.

  2. William Mougayar

    I have seen VCs push for pro-rata rights on the overall ownership, not just on the round, i.e. if they started at 1% of 5MM, they ask for 1% of $12MM. What are your thoughts on that?

    1. davidblerner

      usually they think they are the only game in town when they ask for this- it’s known as super pro-rata rights… I just saw it again last week… VC is following-on but thinks there’s no competition, so demanded right to invest much more than their pro-rata in any subsequent round…

      1. William Mougayar

        It’s almost like greed insurance, wrapped with some arrogance.

        1. davidblerner

          in some ways yes… really torques the entrepreneur- and then makes it super awkward when s(he) asks if the angels want to follow-on as well… we should “follow-on” at inferior terms to the VC in the same round… *awkward*!

    2. fredwilson

      pro-rata rights are on ownership. if i own 1% of the company, i get 1% of all future rounds

      1. William Mougayar

        but % of ownership is not the same as % of future rounds. did I misunderstand your answer?

  3. David Semeria

    In the UK, the right of shareholders to participate pro rata in future rounds is enshrined in company law. I’m surprised it’s not the same in the States.

    1. fredwilson

      really. that’s good to know.

      1. David Semeria

        That’s why capital raises are frequently referred to as “rights issues”. Where the right in question is to participate.

    2. jason wright

      but it doesn’t save employees from being suckered by near worthless B shares issued by A shares holders. All rights are not equal, and that’s enshrined too.

    3. JLM

      .In certain jurisdictions it is in the form of the “doctrine of corporate opportunity”. It is a fringe case.JLM.

    4. Matt A. Myers

      Enshrined as in its mandatory to some degree or just required to be defined?

  4. Dan T

    Fred, this post is very helpful for those newbie entrepreneurs who might not know any better – like me 15 years ago. I appreciate the fact that you want to let the angels and friends & family investors tag along when your firm invests. Not everyone else thinks this way – and you saying this here is great.

  5. pointsnfigures

    Great points, couldn’t agree more. it helps you view investing with “optionality”. There are opportunity costs to each round, and each investment. Pro rata rights allow you to re-diligence the deal, have honest conversations with yourself and the entrepreneur. It helps you let poor companies die, and toss capital into performing companies. Better return in the end.

    1. fredwilson


  6. jason wright

    do some investors try to set the value of the investment round high to exit other investors, as a tactic to grow their equity %?

    1. fredwilson

      not really

  7. JimHirshfield

    What do angels do when they don’t have the resources to participate in future rounds and it’s a clear winner? Eventually, they can’t and they get diluted. High class problem, I guess.

    1. fredwilson

      they get diluted. that’s the last point i made. reserve for follow-ons

      1. JimHirshfield

        They don’t always have reserves by virtue of being the small investor. That was my point.

        1. Matt A. Myers

          Sell your first born?

    2. joeagliozzo

      I’ve often thought there is a very good business opportunity to raise a fund to “buy” pro rata rights from angel investors who don’t have the capital to exercise. You could work a deal with the investor to give them some additional shares or just pay them for the rights and you would have the opportunity to get in on some good deals where the risk profile has been lowered (because a follow on round is occurring) over the initial seed round the angel invested in.

      1. JimHirshfield

        I like that idea. But you would have to overcome the non-transferable clause, right?

        1. joeagliozzo

          I suppose there could be a number of contractual restrictions but I would think you could work around most/all of them because you have the cooperation of the original investor. For example you could execute a note and loan the investor the money to exercise pro-rata rights and take the stock as collateral and then forgive the note in exchange, etc. (This is all provided the company wouldn’t agree or waive the restriction if it exists, which would be the first and most straightforward option.)

          1. JimHirshfield

            Reminds me of a company/fund in San Fran set up exclusively to help startup employees without the financial resources to exercise their stock options.

  8. davidblerner

    As an angel it’s always frustrating to “get bounced” by VC’s in subsequent rounds *even when I have pro-rata rights*. As you know- a lot of VCs (not you Fred) don’t give a flying f— about the angels and squeeze the entrepreneurs (who may have the best intentions). Of course being completely supportive of my entrepreneurs- my hands are often tied. (Sigh)

    1. fredwilson

      that’s a shame

      1. Alan Warms

        It’s happened to me also – I think it is BS. As an angel you are taking max risk and the amount of absolute dollars to satisfy pro-rata is usually small. Especially when you tell the entrepreneur up front how important it is to you. One of many reasons I don’t like angel deals. While Fred I know you are sympathetic to this point – behavior of other super respected VCs who I am friends with leads me to believe that getting your pro-rata rights “undone” is market.

    2. Kirsten Lambertsen

      Maybe there should be a GlassDoor for VC firms.

      1. davidblerner

        Well, in some ways we angels are the living/breathing glassdoor… is “the funded” still out there?

        1. Kirsten Lambertsen

          Ah, yes it is! That’s pretty much it, you’re right.

    3. JasonBoisture

      How do you get bounced if you have pro-rata rights? Do they complete the round before you have a chance to put your money in? Just curious…

      1. Alan Warms

        Two techniques I have seen: 1) the entrepreneur begs you not to participate and exercise your rights 2) the VC who controls your round (if you exercised once) waives the right for the class but then re-ups themselves as new investor in next round.

      2. davidblerner

        I’ve seen yet another way multiple times up front and personal (in addition to Alan’ points)…. This is how it works: you (the angel) find out about the follow-on round when it’s almost done and the CEO tells you it’s oversubscribed and there’s no room… of course you are “in the foxhole” with the CEO so you politely ask if anyone can “make room” (hinting politely at your pro-rata) and (s)he checks for you and the VC’s all say “NO”… then the CEO calls you back and profusely apologizes and then you (the angel) say “ok” and that’s the end of it all… everyone moves on like it never happened…. (and the angel of course has all kinds of thoughts going on his his/her head)

        1. Alan Warms

          exactly. and if you push on it #2 happens

  9. Gotham Gal

    The biggest push back on giving the original investors (angels) their pro rata rights for future rounds are the lawyers. They give advice to their clients (entrepreneurs) that if they give that right to the original angel investors then the VC’s will be less likely to invest in them going forward.Of course that is complete bullshit but that is where most of my push back comes from. Of course I pay it no mind but just to be noted.

    1. David Semeria

      However, the pro-rata right can create problems when you need to chase down lots of small shareholders to get their signatures. The legal docs should be structured so that no shareholder can hold the round to ransom.

      1. Gotham Gal

        I am usually the first to wire. Need to set a good example

        1. pointsnfigures

          Sometimes I don’t even wire. I walk over a cashiers check and hand it to the CFO.

          1. LE

            Sometimes I don’t even wire.Agree. I am very very very proactive with any paperwork and especially payment.I had a deal that I did with a local guy who I knew pretty well (and he was an attorney to boot). He made me wait 3 months for a check and the only reason it wasn’t a COD deal was because I knew him. Now I totally don’t trust him and it will affect our relationship. (The amount involved was $7500).Anyone who has ever extended credit to someone knows how aggravating it is to have to follow up multiple times to get payment and collect. I just don’t get why people don’t understand this and how it effects their reputation (and I’m talking about people with money not people who don’t have the money who you should never have extended credit to).

          2. JimHirshfield

            “Show ME The MONEY”

      2. JLM

        .Any right in business should have a condition that triggers it and a deadline to execute it along with a prescribed methodology to evidence execution.JLM.

        1. LE

          Right. We will notify you this way. If we don’t hear back it will mean you are giving your defacto approval. I’ve done that when sending out documents “if I don’t hear back I will assume everyone agrees with me and we will proceed”.Related fork: When settling an estate there are certain documents that need to be signed (by executors) in order for things to proceed. By all the executors. To which I observed “oh so in other words an executor could hold everything up in order to get their extra pound of flesh by not signing the documents, I get it”. Speaking hypothetically of course.

    2. William Mougayar

      Agreed 100%.

    3. JamesHRH

      When I met my wife, she had just been lured from Shell Canada’s legal group, onto the company’s first ever oil sands project. She & a guy (great guy) named Wally did a job that 200 people were hired to do on the second oil sands project (v large numbers involved here).One day she comes home, um, frustrated. Long soliloquy on lawyers giving business advice v legal advice. A year earlier, she was on other side of this conversation; so, no credibility issue here!It’s a good sign if a founder can look at the lawyer & say: ‘your job is legal advice not financing advice. Explain the legal risks & the practical implications (most lawyers with experience ought to be able to do so). I will make the decision. DO NOT tell me what to do.’Lawyers sit around all day being the smart ones. It causes boundary issues.

      1. LE

        It’s a good sign if a founder can look at the lawyer & say: ‘your job is legal advice not financing advice. Explain the legal risks & the practical implications (most lawyers with experience ought to be able to do so). I will make the decision. DO NOT tell me what to do.’I don’t think that’s a good idea. Not at all. I would never do that.I think you let people say whatever they want and then make whatever decision you want to make in the end. You don’t ever want to cut off advice because then they might very well spite you.By copping an attitude “‘your job is legal advice not financing advice. Explain the legal risks” and “DO NOT tell me what to do.'” you don’t build rapport with the professional. [1]I had a electrician come and tell me that he didn’t think I needed to replace the light fixture I could just replace the parts. That’s fine and it’s his opinion. I don’t have to make him feel bad by telling him to “mind your own business” or anything like that.[1] Imagine if you hired JLM as your corporate coach. And he told you that he thought you should not buy a particular make and model of car. And you said “listen JLM I don’t really care what you think about cars at all so I’d appreciate if you’d stick to being my CEO coach. Do NOT tell me what to do”. Hopefully if you are hiring professionals you think of them highly enough to at least appreciate and listen to them and consider when they care enough about something to give their opinion about that. Which is not the same as buying the same car that they suggest to you (and they know that as well).

        1. JamesHRH

          You are talking about How.I am talking about What.

          1. LE

            Can you explain that?

          2. JamesHRH

            Founder has to be able to identify when an advisor is stepping outside their role &, perhaps, more importantly, when advisor has not fully performed the role (provided all legal options, risks, impacts) but has ‘locked on’ to a course of action.’Locking on’ is basically making the decision.My wife has a very strong ability to sense / see when people are not performing or overstepping their roles / boundaries.

          3. Rick Colosimo

            That’s inapposite in the startup world vs the corporate world. Corporate legal teams typically have very well-defined roles and responsibilities.My startup clients (been doing this work for 15 years) often have less business experience than me, have never done a financing round in any role, have only random anecdotes to guide their decisions, and have never hired or fired anyone in their life. They come to me, and lawyers like me, particularly because we (1) sketch out the legal issues, (2) tell them how the market allocates or manages these risks, and (3) give them particularized advice on how to balance the issues in their situation. That’s not always a yes/no: sometimes it’s a “if x is more important to you than y, then choose this approach and adjust z accordingly.”There are no legal issues. They’re all business issues. That’s what folks like me know, and our clients need us to know it.

          4. JamesHRH

            Rick , you are good at what you do.When you are not, the phrase ‘ there are no legal issues ‘ is a problem.Trust me, a strong leader does not need to know everything but they sure as hell need to know who makes what decisions and how to make them.

        2. JLM

          .Tangential to the conversation, I know.One of the things I have learned in the last two years is to be careful making recommendations. A coach should “coax” a decision from a CEO rather than champion a particular course of action,”I’ve seen it done this way before…””I’ve done it this way before and it worked.””Here are the alternatives, let’s chat them through.”It is essential to the CEO’s long term decisionmaking skills that she actually make decisions and know how to frame and staff them.At the highest levels this is critical as shown by the comparative decisionmaking skills of, say, Eisenhower and Obama.DDE knew how to make his staff frame a decision and then to implement it. BHO has no clue.As a result, DDE was a doer and BHO is a talker.In fairness, wildly different professional experience and preparation.JLM.

          1. LE

            DDE had to pass through so many more doors than BHO to get to where he ended up.BHO had only two doors. Harvard and then Oprah.

          2. awaldstein

            The more you know the better you listen.The more you have to say, the more you focus on what others hear.Telling people what to do doesn’t work.Delivery is more than half the job.

    4. LE

      Just wrote a whole reply to this but disqus failed to post it. Now it’s gone. Very annoying.

      1. JimHirshfield

        On mobile? On spotty bandwidth? Did you wait to see what happened after the blinky dots?…or just hit refresh after a while? Usually, Disqus will return to opening the “post box” with your text in the box when it fails to post your comment.

        1. LE

          More importantly how do I delete the graphics below? Obv. the wrong graphic is appearing.Simply doing edit does’t allow me to do this at all.Let me know asap. I also logged into disqus and there is no way to delete comments and especially graphics.

          1. JimHirshfield

            You can’t delete images once they’re posted. cc a moderator and ask them to delete the whole comment.

          2. LE

            The behavior is such that if you post the wrong image, hit the delete “x” and then post another image the original image still appears.Not only that but in this case (since I knew that) I started from scratch and it still posted the image that I had “x”‘d out.This is really really really bad behavior.By the way as far as “cc a moderator” I happened to know who the mods are (and have both of their emails). But you know that most people don’t know who the mods are. So the question is why is there no way to delete an image and why when you “x” out an image (before hitting “post”) doesn’t the image get deleted.So this needs to be fixed. It’s happened to me several times.

          3. LE

            Separately it’s bad security wise to allow people to scrap images by simply coming up with a sequence numerically +1 and be able to get all of the images that have been posted:…(Change the numbers and you get hits frequently. Sometimes you don’t but that’s not big deal when you are scraping.).It would be trival programming wise to randomly use a letter sequence in both places instead of “873/1010”. So for examplegWTMNUusUd/mnYjd6s etc.Also someone could use this to post pictures that even once the mods deleted were viewable anywhere anytime.

          4. awaldstein

            This is is really bad bug Jim.I’ve pulled images by mistake and it is an embarrassment to leave them and one to ask to remove them.The reason for not fixing this? Scratch that question, for this one no reason is good enough πŸ˜‰

      2. obscurelyfamous

        That really sucks. We are digging into it. Sorry

    5. fredwilson

      i just featured this comment

    6. ShanaC

      have you ever seen the lawyers be right

  10. BulldogSpirit

    Thanks for this Fred. Assuming a pro-rata right exists, in your experience if the firm struggles and future rounds are at discounts to your original price, is it generally better ( and I recognise all situations are unique) to follow your money as an angel, or to stop?

  11. reece

    i’ve seen cases where lawyers recommend pro-rata rights only for majority investors (ex: in a seed deal, anyone above $100k)…but it sounds like you think all investors, especially all angels, should have pro-rata rights?

  12. reece

    also, lawyers are just trying to protect their client as much as possible…so if they don’t HAVE to give pro-rata rights off the bat, then they won’t. once it’s in there, it’s in there… thus, they leave stuff out until a case is made to add itthat’s been my experience anyway

    1. davidblerner

      Yes and my point above is that even when an angel *has* pro-rata rights it doesn’t mean (s)he actually gets them… Lots of times VC’s roll-in and torque the entrepreneur and the angels pro-rata get trampled on… Then the CEO has to say, “I’m really sorry” – and they mean it b/c the VC’s said to them at one point “we’re taking all of it, capice?!”

      1. reece

        yup… it’s all just paperwork anyway…

    2. Sang Lee

      Doesn’t mean that they are necessarily ‘protecting’ their clients. It’s a narrow road to tread…

  13. Twain Twain

    If the chemistry is great between the founder(s) and their seed investors and both sides are adding value to each other, it makes sense to consider offering pro-rata rights to those seed investors — particularly since they are overcoming the biggest gradient of risk with the founder.However, there are cases where the seed investors aren’t “smart money” and the relationship with the founder(s) doesn’t help either side achieve their value objectives.In that situation, pro-rata rights act as a bit of a ball & chain to the founder. It’s a percentage of equity they can’t make available to another set of investors who could add significant value.

  14. Matt A. Myers

    @danielha:disqus – I have two reply comments that are stuck on the loading / processing dots. Still waiting after ~15 minutes. Trying this as a main comment to see if it’s doing it here too.. guess we’ll find out. πŸ™‚

  15. Semil Shah

    For my fund, which is new/unestablished, I sort of decided I wouldn’t be in any position to ask for or earn a pro-rata, but hopefully I can over time. As things get more competitive, it really does come down to the founder going to bat for the earlier investors, as investors who come in later are increasingly wanting to own the entire round. This all may make sense as founders remain in control (to a point) and incentives reward those who help them.

    1. Matt A. Myers

      This is a smart way to go about it. I am happier to allow certain investors a pro-rata mainly depending on who they are, what they represent if being an investor in my company, because I know they at minimum are adding that value by becoming an investor. New or unestablished funds haven’t necessarily yet shown that they add enough value early on. Obviously it’s more complex than this. It’s all a matter of every player knowing what cards they hold and knowing how to best play them so everyone can be happy at the end of the game.

      1. Semil Shah

        Matt, that’s exactly right. As I’m soft-circling Fund #2 right now, what I’m trying to measure is — how much will the market allow me to invest? I may say I want to invest $x per deal, but the market may not bear that yet. So, I have to constantly calibrate for this. It’s not what I want to invest, it’s what the founders will let me invest.

        1. Matt A. Myers

          I jokingly want to say you can give me all your money – though i don’t want anyone’s money at this point except from supporters and people who truly believe in what I’m doing – through a crowdfunding campaign I’m preparing for.What you said re: a new fund – It makes me wonder if investors already know what companies they want to invest in (perhaps have their top, middle, and bottom picks for each sector), with a range allowing for variability in total amount and cost per equity, etc.. Do you already have ideas for the majority of the startups you’d want to invest in?

          1. Semil Shah

            That’s a different kind of question, and I think each investor approaches their markets differently. I can only share what I do, what I know. I have three channels that I play in. One, I have a very short list of companies I’d like to invest in, and I proactively seek them out. Two, I make sure to meet lots of people and pay attention to what they’re saying. Information travels fast and f2f connections convert quickly. Three, I focus on mobile so other people leading mobile deals will (hopefully) be interested in getting my opinion on something.

          2. Matt A. Myers

            Sounds like a sound plan.Re: Focus on mobile – I’ve read some posts on your blog, but do you talk heavily about the mobile environment then?And now your post on Startups Movements has caught me.. maybe I’ll comment. πŸ˜›

          3. Semil Shah

            Not sure I understand your question, but feel free to send me an email anytime. It’s on my site.

  16. Emily Merkle

    Slight tangent, but one of the things my husband and I have learned – working primarily in tech startups for the past 12 years – is: do not encumber yourself. Having an encumbrance (Non-compete) viciously enforced was the fire lit under us to take the plunge into serial entrepreneurism.

    1. Matt A. Myers

      I don’t follow what you mean. Maybe I am not understanding some terminology?

      1. Emily Merkle

        The space I grew up in – digital media/analytics/networks/lots of money – the value of the company is the people. We don’t “make” anything, and most of the time ownership knows far less than we do about the business. Tat being the case, in order to sign on to a digital startup, on must sign a (typically) 1-year non-compete. Meaning, you cannot work for any company vaguely resembling their competition. Whether you quit or get fired, said employer has the discretion to enforce this clause or not, and to varying degrees.

        1. Matt A. Myers

          Ah. So you’re saying don’t have non-competes ? And thank you for your response.

          1. Emily Merkle

            I am saying – don’t sign them. And yes, personally, I am against them altogether.

          2. Matt A. Myers

            I’m undecided mostly because if someone signs an NDA, assumingly they’re going to be exposed to things that won’t be released for X number of months (or perhaps years) – though then if that person goes to another company, a competitor, sure they could be under an NDA – but it’s going to be hard to prove that they divulged NDA-related information – strategy, ideas or otherwise. A non-compete is clear cut – though you mentioned viciously enforced, so I guess I see it being enforced reasonably. It opens up a bit of a pandora’s box either way.

          3. Emily Merkle

            The vicious enforcement was a former employer throwing lawsuits at us and our startup because we executed better than he did and his revenue base reallocated funds to us. We literally could. Not. Work. To. Support. Ourselves – for a year – and had to fold our very, very promising startup. That’s inept spite, not reasonable enforcement.

  17. Sang Lee

    This is a great point and something that all entrepreneurs should be cognizant of. While pro rata rights are great for investors, to a certain point you should be comfortable getting in bed early on with someone that will be a helpful force for you as you grow the business into subsequent rounds. Always think of it as a long term relationship where you want to give and retain upside for your earliest supporters. While ‘acknowledging’ the perspective of VCs having resistance to this concept, entrepreneurs should also remember that they would not have gotten to the VCs without angel investors.Lawyers are definitely a force during these discussions (obviously not referring to my friends and counsel), but protecting your client and preventing awesome angels from getting involved is just shooting yourself in the foot as a professional advisor.Interesting question would be how this should play in the crowdinvesting schema? It’s hard to see numerous investors trying to fight over pro rata rights without really putting a good amount of skin in the game.

  18. Bob Troia

    @fredwilson:disqus Where did the VoiceBunny audio versions of your blog posts go? I enjoyed “listening” to AVC each morning while on the subway!

    1. LE

      Voice bunny added a “vig” for usage that was egregious for the value.

      1. Bob Troia

        Bummer. I guess I’ll need to whip together something using IFTTT or Zapier to generate my own spoken versions πŸ™‚

  19. LE

    I just read this (was a link on HN):…Where it says:A frequent theme is how to not get screwed by your venture capitalists. YC dinners are off-the-record, so I won’t share any of the details of the talks we experienced, but they’re enjoyable.It’s like a secret society, eh? So YC funds startups (and even non profits) that follow a certain mantra of “change the world”, openness and all these “old school is wrong we are different” but then they have “off the record” dinners where you need to be fearful of letting something out in the open that is said. So all info is free just some is less free that other info.Obviously I fully support keeping things close to the vest (it’s what I do for sure) and fully believe in the concept of “loose lips sink ships”. But then again at least I’m not a hypocrite and it’s consistent with what I actually say and do all around.

  20. RonaldIWilliamson

    As things get mosre competitive, it really does come down to the founder going tos bat for the earlier investors, ass investors who come in lsater are increasingly wanting to own the entire rounds. This all may msake sense as founders remain in control (to a point) and incentives reward those wsho help them.

  21. sigmaalgebra

    Sure you want the pro-rata participation right. OfCOURSE you do.Here’s one solid reason why:At the first investment, usually the success of thecompany in the future is not known exactly. Or,from Yoda, “Always difficult to see, the future.”.Maybe if the company were really successful, itwould raise $50 million, but it would be rare andusually reckless to invest the whole $50 million asthe first investment. So, typically, the firstinvestment is smaller.So, we have two cases:(1) Make just the first investment but no more.(2) Make a first investment but with ‘rights’ formore later.Here’s the “solid reason why”: Likely, (2)’dominates’ (1), that is, no matter what the unknownexogenous inputs over time, (2) is always at leastas good and in practice better than (1).We could call (2) a ‘sequential investment’ as in’sequential decision making’ as in ‘sequentialtesting’ in statistics as in some of the work ofAbraham Wald.Roughly the advantage is that get to make decisionsover time and, then, make use of additionalinformation since the last investment.Much the same thing put another way, the ‘right’ isan ‘option’ that, in case of another round offunding, gives you the “right but not theobligation” to invest again. Typically an optionthat grants a right but not an obligation is worthsomething. So, a pro-rata participation rightshould have some value.Such ‘sequential’ decision making is close tostochastic optimal control.An old example of Wald’s idea was testing soldiersfor VD: So, take the samples from, say, 50soldiers, combine the samples, and test. If see noevidence of VD, then just saved 49 tests. If do seeevidence of VD, then test the 50 soldiersindividually, that is, a total of 51 tests. Likelyhave some big savings on the number of tests have todo.So, don’t have to be limited to just two testingtimes, and get to select a number other than 50.Then a question is, what ‘sequential’ techniqueyields the least cost for testing?Quite generally, when working under uncertainty, isthere any other case?, making decisions over timebased on the latest information is much better.When we have some more powerful computers, here’s a’business idea’: Suppose Joe is at UGE Corporationand using Excel to develop a five year capitalbudgeting plan. Yup, Joe is planning over timeunder uncertainty.Suppose Joe does his plan with monthly periods, thatis, 5 * 12 = 60 months, with one column in hisspreadsheet for each month, 61 columns in all.Suppose he has one variable for each row.Many of the cells have algebraic expressions interms of cells in the same or earlier columns.Some of the cells represent capital budgetingdecisions to be made.Some of the cells have values of unknown, exogenousvariables, e.g., interest rates, after tax earnings,prices of items to be purchased, actual projectcompletions times, etc.And the number in the last row in column 61 is theestimated expected discounted present value of thewhole effort, and Joe wants to maximize that.So, first cut, Joe inserts constants for theexogenous quantities and the decisions and asksExcel for the value he wants to maximize.Finally after trying lots of decisions all night,Joe discovers that Excel has some optimizationsoftware built-in, maybe L. Lasdon’s generalizedreduced gradient 2.0, GRG2, that, on a good day,will find the decisions for him.But, still, Joe is making and fixing the decisionsfor all 60 periods at the beginning. This is liketelling a US football quarter back to call all fourplays on first and ten. Bummer.Instead, Joe needs a way to make decisions over timemaking use of the unpredictable exogenous data knownfrom earlier periods.If Joe can get probability distributions for theunpredictable, exogenous data, then his maximizationproblem is covered by ‘discrete time stochasticoptimal control’ or ‘dynamic programming’ — that is’dynamic planning’ where the ‘dynamic’ part is thatthe planning changes or evolves over time.If Joe can’t get such probability distributions,then he can guess at some and, thus, do a betterthan usual job at ‘sensitivity’ analysis and knowhow far to stay back from the edge of the cliff.Names of experts in such things include R. Bellman(Los Alamos, RAND, USC), E. Dynkin (Cornell), R.Rockafellar (U. Washington), D. Bertsekas (MIT), S.Shreve (CMU), S. Dreyfus (Berkeley).Yes, cloud computing does help the prospects here!Will want to look into multivariate splineapproximations for a lot of data that otherwisewould be discretely tabulated, consider as a good,first approximation ‘certainty equivalence’ thatworks in some common cases, make some progress withRockafellar’s ‘scenario aggregation’, carefullyparse the algebraic expressions to take advantage ofwhat is independent of what else, etc.Entrepreneurs looking for a ‘business idea’, don’tworry about missing out on something: I haveoverwhelmingly strong evidence that there is not asingle VC in the world who would invest even 10cents in such a software project!

  22. John Ramey

    Although a normal term, it seems unfair to the founders. The VC’s have the right to not continue working with the company / founders, so why can’t the founders decide to stop working with the investors in “new” business (future rounds)? Investors should earn their spot based on merits.

  23. Matt Zagaja

    Always remember that the first guy to the party gets to pick the tunes.

  24. Robert Holtz

    Really great advice, Fred. Thanks for taking this on.

  25. RacerRick

    Entrepreneurs should always want the pro-rata rights. You should always want your early investors to keep investing.

  26. jonsteinberg

    I switched to android over the weekend. I turned on Hangouts for SMS and literally this morning had the same experience and reaction and reverted to the native SMS app. Trying chomp now.

  27. Peter Thomson

    While pro-rata (or pre-emption rights as we call them in the UK) are an important term for investor protection. I’m not so sure that they should be treated as always a good thing to exercise. If you specialise in investing at a certain stage then “following your money” just means that you are doubling down on a bet you will already see upside on. Would you generally be better continuing on with the hunt for the next deal? Preventing dilution using pro-rata might be important to maintain a percentage for a board seat etc, but in a syndicated round is it really ever relevant?

  28. JimHirshfield

    For sure. Understood.Just sucks to be in early and not fully partake.

  29. fredwilson

    you must be referring to my wife when you say lovely and charming πŸ™‚

  30. PhilipSugar

    Maybe its just me (I’ve never done the angel thing on either side). Isn’t the new investor going to want the signatures of all of the stockholders?That was always my biggest worry about taking angel money. If you have ten people guaranteed one is going to be crazy. Who knows why or for what but one will be crazy.My others are as a small investor you take all of the downside for little upside, and every upside event there is a temptation to squeeze you out.

  31. JimHirshfield

    It’s not _fully_ if you don’t keep the same percentage position.

  32. LE

    Now just wrote an entire reply to this which disqus failed to post.Hey disqus this is the 2nd time this happened today to me.

  33. LE

    that was a universal suckup, all inclusive.I don’t get why you couldn’t just do that with the music execs.

  34. SAS

    This is a very educational discussion, thank you all for sharing your knowledge. As a budding angel investor, (forgive my naivete), I’d like to ask you to make this absolutely clear for me with an example:Let’s say I invest $50,000, in a company that is valued at $1,000,000. The $50,000 bought me 100,000 shares. I own 5% of the company. Let’s say that the company is doing well and now go for a Series A round. I have pro-rata rights. The company will now be valued at $10,000,000.1) In order to but into the next round, I would need to know how many shares are being offered in this round, and buy that amount at the new share price up till I reach my 5% ownership again. If the company is now worth 10x of what it was when I first invested, I may have to pony up $500,000 to keep my 5% ownership (assuming the same amount of shares are being offered in the Series A round as in the initial offering).2) If I don’t invest in the Series A round, the value of my shares will go up (if it is an up round). Will they not go up 10x because the value of the company is now 10x of what it was?3) When you say “get bounced” does that mean that in future rounds I would be forced to sell off my shares, regardless of whether I choose to purchase more shares?I’m trying to understand what the true downside is. I see the upside.. if a company is doing well, you have the opportunity to buy more, but if I’m only investing $50,000 – $100,000, my 1%-5%, may not buy me a whole lot of influence. But if the company I invest in continues to do well, and for example is now valued at $100 million, then my $50,000 initial investment should now be worth 100x or $5,000,000.What am I missing?

  35. JimHirshfield

    New shares are issued by the company in subsequent rounds….you don’t sell your shares to new investors as a normal course of business. So, with more outstanding shares, you could become diluted (own a smaller percentage of the company) if you don’t invest more in subsequent rounds.

  36. SAS

    Is there ever a scenario which you can be diluted down to 0? I assume this could only happen in down rounds.

  37. LE

    I think you need to bogu as well though.

  38. LE

    My original comment sans graphics: On mobile? No desktop.On spotty bandwidth?Definitely not. I just pulled 18.5 Mbps down/ 3.55 up. And I’m running shellwindows all over the place that constantly refresh. Definitely notspotty bandwidth here (I know it when that is the case).Did you wait to see what happened after the blinky dots?…or just hit refresh after a while?I waited literally a few minutes. This is not the first time this has happened. I’m not a newbie after all. This happened three times (now four) times today already (and has happened here and there on other days).Usually, Disqus will return to opening the “post box” with your text in the box when it fails to post your comment.I’ve never ever had that behavior.Btw I’m running Firefox 27.0.1 but this has gone on back and forth for a long time. I actually got into the habit of copying my comment [1] before posting it was happening frequently enough. (And you know most of my comments tend to be long).[1] cmd-a cmd-c. Actually it just happened luckily I had a copy. See attached it’s going on so I replied again and hopefully this will work.

  39. pointsnfigures

    True story-off topic. One of my best buds that was a trader (He’s passed away now since 2001) once walked into a Mercedes dealer in the most tattered clothing you could imagine. He had a pot belly, and the belly was coming out from under his shirt. Unshaven, unshowered. Carrying a shoe box.No one paid attention to him. Someone mentioned he should leave. He walked up to a car, and started laying $100 bills on the hood!Sales guy sees this, grabs him and takes him in the office. They negotiate the price, and the sales guy says, “How are you going to pay for that?”He said, “Shoebox”. Shoved all the cash at him in the shoebox! This was back in the 80’s when you could do shit like that. He won the money playing poker.

  40. Matt A. Myers

    More maximizing potential return? If you have pro-rate right then you have a guaranteed ability to invest more. Maybe you wouldn’t have that ability otherwise, though as @ccrystle:disqus said the value of your existing shares still are going up.

  41. Matt A. Myers

    That would feel horrible.

  42. Matt A. Myers

    So fully maintain previous position, % wise?

  43. JimHirshfield

    That would be “fully”, IMO.

  44. Rick Mason

    Reminds me of the story about Grace Slick when she went shopping for an Aston Martin. The sales guys tried to throw her out until she showed them she had the means to buy a DB6.http://phscollectorcarworld

  45. LE

    He must have really looked like crap. Because in general luxury car dealers actually take the people who are confident enough to walk in in tattered dungarees as being better potential customers in the end than a guy who walks in with a suit. In the case of a lower end dealer I do not believe it is the same though. Only high end.In Princeton NJ (I’ve mentioned this) the lux dealers there (Porsche/BMW/Mercedes) all relate stories of kids who are given money by their parents to “buy a car” and just go buy an expensive car just like that.In my first business a good customer that I ended up with walked in the first day in the rain with a trash bag and looked like a bag man. I’d like to tell you that this was some great lesson but I actually found, at least in my business, that suits meant something that it was actually an outlier. Each situation and business is different.

  46. LE

    See now I would have stuck on the point of the original deal and simply dragged things on for a week or two somehow some way. Then when he lost all his steam I would have given him $50 which he would gladly take. Feeling that he wouldn’t get anything at all.The “lose steam” is really key. Anger dissipates and people are way more likely to just “go along” after they have lost the initial “umph” of anger.You need to put distance between the event and the resolution but without having the person get angrier of course. (A fine line..)

  47. William Mougayar