I don't agree with this, pro-rata rights protect investors from dilutionary events which they have no control over. I guess that's one-sided in the way that any "right" is in a legal contract, but that's a weird way to frame it.
It's also incorrect to frame the option as "free", you're only observing market behavior in a world in which the option exists, not one in which it doesn't exist. You can't say that investors would have the exact same behavior (in terms of prices, terms, etc) in a world in which they rarely or never got pro-rata. Maybe, but probably not.
Are you actually disagreeing with him, though? Pro rata is clearly a good thing for investors. But many founders just treat it as a neutral thing for them. I think and the author should both agree that a founder should slightly prefer the identical terms without a pro rata.
If founders keep this in mind, they might be able to get a better deal while negotiating. Yeah, investors won't act exactly the same way, but that's okay. Some investors don't care for pro rata rights, and those investors should be getting a slightly better deal in exchange.
>the author should both agree that a founder should slightly prefer the identical terms without a pro rata.
Framing in language like "prefer" is misleading the analysis of the situation.
The gp's point is there are unstated market forces of leverage that affects both sides ability to negotiate the terms they want -- but can't always get.
As other examples, consider "liquidation preference" or "50% ownership":
- Sure, a founder would "prefer" that there is no liquidation preference. But that preference is meaningless because investors won't invest money without it. Therefore the "unseen" alternate universe is the startup founder that convinced a hypothetical investor to pay millions with unprotected zero liquidation preference. Since that alternate universe doesn't exist, the current reality is that the investor has leverage on this term.
- An angel investor would "prefer" ownership percentage of 50% instead of 7%. But that preference is meaningless because most startup founders would not give up that much ownership because it's no longer worth it to build the company. The founder has leverage on this term.
Both sides want things they can't get.
Overlayed on top of this is shifts in leverage because of the balance of power between the available funds -vs- # of quality startups. If there's more money chasing the available startups with strong founders, they may have leverage to eliminate "pro rata". This wouldn't have been possible in the investing climate of 2008 when all VC funds got tighter with money.
I agree but then circumstances to defend against are pretty limited. Effectively a situation where a founder with control issues new shares at an arbitrarily low price to a new set of individuals. There has to be a more elegant tool to defend against that kind of event.
Comments
I don't agree with this, pro-rata rights protect investors from dilutionary events which they have no control over. I guess that's one-sided in the way that any "right" is in a legal contract, but that's a weird way to frame it.
It's also incorrect to frame the option as "free", you're only observing market behavior in a world in which the option exists, not one in which it doesn't exist. You can't say that investors would have the exact same behavior (in terms of prices, terms, etc) in a world in which they rarely or never got pro-rata. Maybe, but probably not.
Are you actually disagreeing with him, though? Pro rata is clearly a good thing for investors. But many founders just treat it as a neutral thing for them. I think and the author should both agree that a founder should slightly prefer the identical terms without a pro rata.
If founders keep this in mind, they might be able to get a better deal while negotiating. Yeah, investors won't act exactly the same way, but that's okay. Some investors don't care for pro rata rights, and those investors should be getting a slightly better deal in exchange.
>the author should both agree that a founder should slightly prefer the identical terms without a pro rata.
Framing in language like "prefer" is misleading the analysis of the situation.
The gp's point is there are unstated market forces of leverage that affects both sides ability to negotiate the terms they want -- but can't always get.
As other examples, consider "liquidation preference" or "50% ownership":
- Sure, a founder would "prefer" that there is no liquidation preference. But that preference is meaningless because investors won't invest money without it. Therefore the "unseen" alternate universe is the startup founder that convinced a hypothetical investor to pay millions with unprotected zero liquidation preference. Since that alternate universe doesn't exist, the current reality is that the investor has leverage on this term.
- An angel investor would "prefer" ownership percentage of 50% instead of 7%. But that preference is meaningless because most startup founders would not give up that much ownership because it's no longer worth it to build the company. The founder has leverage on this term.
Both sides want things they can't get.
Overlayed on top of this is shifts in leverage because of the balance of power between the available funds -vs- # of quality startups. If there's more money chasing the available startups with strong founders, they may have leverage to eliminate "pro rata". This wouldn't have been possible in the investing climate of 2008 when all VC funds got tighter with money.
I think you're correct, but that's not how I read the article.
https://joelx.com/conversation-with-a-venture-capitalist/169...
I agree but then circumstances to defend against are pretty limited. Effectively a situation where a founder with control issues new shares at an arbitrarily low price to a new set of individuals. There has to be a more elegant tool to defend against that kind of event.
Not really. Simple basic company structures are preferred when possible. Hot stocks get funding regardless.