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Defending Your Pro-Rata Rights: How VCs and Angels Can Monetize Growth Rounds and Avoid Leaving Millions on the Table

This article is written by Sam Silvershein at Alpha Partners, a tech growth equity fund that shares carry per deal and sources opportunities from 1,100+ early-stage investment partners. Leveraging our partner-driven origination and information advantages, we selectively invest in the most promising Series B and later companies within our partners' portfolios. 

Zach Ginsburg’s and Alex Pattis’s recent article, "The Pro-Rata Trap: How VCs Lose Millions on Their Biggest Winners," struck a chord with the venture capital community and highlighted the critical challenges investors face in defending their pro-rata rights. For early investors, these rights are more than just contractual obligations—they're a lifeline to maintaining significant upside in their most successful investments. Yet, the journey to defend these rights is fraught with challenges.

In this follow-up post, we’ll take their discussion a step further to illustrate exactly how VCs and angels can monetize their access to leading growth rounds, defend pro-rata rights, and avoid leaving significant upside on the table. We’ll also discuss how partnering with a specialized growth fund like Alpha Partners can turn these challenges into opportunities.

The Importance of Pro-Rata Rights

Pro-rata rights enable investors to maintain their ownership percentage in a company by participating in future financing rounds. For early-stage investors, these rights are critical. As companies progress to later stages their risk diminishes and the potential for outsized returns increases. They find their product-market fit, market position, and scale their operations. Participating in these rounds can significantly enhance an investor’s overall returns.

However, exercising pro-rata rights is often easier said than done. Founders, eager to find fresh capital and strategic value, may prioritize newcomers over existing investors. New investors at the later stages typically want to secure a specific ownership percentage, creating a tug-of-war with existing investors who wish to double down on their previous bets. This clash of interests often leaves early investors squeezed out, unable to maintain their stakes in the very companies they helped build.

The Realities of Winning Pro-Rata Share

The pressure to exercise pro-rata rights intensifies as companies enter high-demand fundraising rounds. These rounds often have tight timelines, and in such fast-moving environments, raising a Special Purpose Vehicle (SPV) from Limited Partners (LPs) can be challenging. Early-stage VCs frequently find themselves unable to secure additional capital from their LP base through SPVs due to time and capital constraints, leaving them with limited options. As a result, early investors are often forced to give up their allocation without gaining any additional upside.

Companies’ earliest funders, in particular, are acutely aware of the difficulties in defending pro-rata rights during these high-stakes rounds. The negotiations that happen behind the scenes are often anything but pretty. Founders are eager to bring in marquee investors, and in turn, they may prioritize those relationships, sometimes at the expense of existing investors. Meanwhile, later-stage investors, armed with significant capital, tend to leverage their position to secure favorable terms.

Nonetheless, companies seem to benefit most from a blend of new and established voices – balancing fresh perspectives with thought leaders from the early days. The earliest investors possess deep insights into the company's operations and market, and they continue to offer strategic value that shouldn't be overlooked in favor of fresh capital alone.

Capitalizing on Your Insider Edge

Early investors benefit significantly from timing and insight. Given their history with the company, they possess a deep understanding of its metrics and the overall opportunity. This knowledge can and should be leveraged to secure pro-rata rights before rounds become overly competitive.

Rather than scramble to invest on the back of a new term sheet when everyone else is vying for a piece of the action, early investors should initiate conversations early and proactively. Communication with founders is crucial, as is angling for future rounds well before they hit the market. By working with a partner like Alpha Partners, early investors can proactively secure their pro-rata rights without being caught in a last-minute scramble.

Monetizing Access to Growth Rounds

So, what options do investors have when they find themselves unable to fully exercise their pro-rata rights? Several strategies can be considered:

1. Syndication: Early-stage investors can bring in co-investors to help cover the capital required to maintain their pro-rata share. While this approach allows them to retain their rights, it is time-consuming and may not always be feasible in a fast-moving market.

2. Raising an opportunity fund: Some VCs opt to raise an opportunity fund specifically designed to invest in later rounds of their most promising portfolio companies. While this allows them to defend their pro-rata rights, it’s not without challenges. Deployment cycles can misalign between the core fund and the opportunity fund, and LPs may be reluctant to commit additional capital to both strategies or seek to avoid becoming overexposed to specific assets. 

3. Secondary sales: Selling shares on the secondary market provides liquidity and allows investors to lock in gains from earlier rounds. However, secondary sales typically come with a discount to the company’s latest valuation, and selling too early can mean missing out on future upside.

4. Partnership with a growth fund: This is where Alpha Partners and a few other pro-rata funds typically come into play. By partnering with a growth fund that specializes in growth-stage investing, early-stage VCs and angels can effectively monetize their pro-rata rights. Alpha Partners provides the capital needed to exercise these rights, and in return, both parties share in the upside.

The Upside You're Leaving on the Table

Missing out on pro-rata opportunities can drastically impact returns. Imagine investing $1 million at a $10 million valuation.  If the company later exits at $1 billion, your initial stake could be worth $100 million – if you maintained your ownership. But failing to invest in later rounds often leads to dilution, which would significantly reduce your potential gains. This is the harsh reality of venture capital's power law: most returns come from a few exceptional companies.  Missing out on those growth rounds can mean missing out on career-defining returns.

Why Work with a Pro-Rata Fund?

For many early-stage VCs and angel investors, partnering with a growth fund like Alpha Partners or other pro-rata funds is an attractive solution. Alpha Partners focuses exclusively on helping investors capitalize on their pro-rata rights by providing the necessary capital for later-stage rounds. This allows you to:

• Maintain ownership: Preserve your ownership percentage in your most successful portfolio companies.

• Maximize returns: Capture the upside of growth rounds without the burden of raising additional capital.

• Focus on early-stage investing: Continue to do what you do best—identify and invest in promising early-stage companies—while leaving the later-stage investing to specialists.

• Efficiency: Quick and transparent investment decisions. 48-hour initial turnaround and approximately two weeks of diligence, with flexibility to move faster. Access to management is not required (but is preferred). 

• Flexibility: No ownership mandate, no board seat requirement, and flexible check sizes. There's no need for the partner VC to invest and Alpha sets up the SPV to invest and covers all expenses related to it. Alpha’s name doesn’t need to be on the vehicle. 

Conclusion

Pro-rata rights are a powerful tool for venture capital and angel investors, but they come with challenges. By understanding the options available to monetize your access to growth rounds, and by taking steps to defend your pro-rata rights, you can ensure that you capture the full upside of your best investments. Whether through syndication, opportunity funds, secondary sales, or partnering with a growth fund like Alpha Partners, the key is to be proactive and strategic. The millions of dollars left on the table in unexercised pro-rata rights could be yours with the right approach.

About Guest Author Alpha Partners:

In 2014, Alpha Partners pioneered the original pro rata growth investor strategy — we co-invest with the world’s best VCs by sharing economics with early-stage investors. We access top tier growth-stage investments by providing fast, friendly capital to early-stage insider investors. Today, Alpha sources deals from a network of more than 1,100 VCs and stands out as a superconnector in the venture industry. 

By working with us, you can maximize returns on your top-performing investments. 

You can reach Sam via email at [email protected] to learn more about how you could partner to achieve exceptional results.

If you enjoyed this article, feel free to check out our prior articles on resources: 

• Deal Machine or Selective Investor: Which Syndicate Style Wins?

• The Pro-Rata Trap: How VCs Lose Millions on Their Biggest Winners

• Breaking Down the Secondary Transaction in Venture Capital

Last Money in is Powered by Sydecar

Sydecar empowers syndicate leads to manage their investments more effectively. Organize, manage, and engage your investor network effortlessly with Sydecar’s management and communication tools. Their platform also automates banking, compliance, contracts, tax, and reporting, freeing up syndicate leads to focus on securing deals and strengthening investor relations. Elevate your syndicate operations with Sydecar.

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✍️ Written by Zachary and Alex