My buddy Maneesh Arora asks:
Have you successfully been able to get pro-rata rights as an angel (assuming putting in small-ish amounts of money of $25k or $50k, something along those lines), on Convertible Note deals?
This was in response to my old post Taking Your Pro Rata as Angel Investing Strategy.
First, given that I’m at Launch Capital now and our investment sizes are $100K-$150K, we typically fall into the camp of auto-qualifying for pro rata rights in equity deals (many equity deals have a restriction that only “Major Investors” get pro rata rights, with a “Major Investor” being defined as someone who invests a minimum amount of money).
I looked back on the last few deals I have done, both equity and convertible notes. With respect to pro rata, I have found:
1. Most angels don’t invest pro rata or they don’t understand the effect of pro rata investing, so they don’t speak up when the round doesn’t give them pro rata rights for whatever reason.
2. Bigger funds tend to put limits on who gets pro rata and who does not on subsequent rounds. It would seem natural that they would want to keep as much ownership as possible, and future ownership rights too.
3. Smarter entrepreneurs will use pro rata rights to entice every investor to put in more money. But that does not help the angel who simply does not have enough resources to produce the minimum amount.
4. There are investor entities who are more friendly than others to angels in the round. They tend to give pro rata rights to everyone regardless of the investment amount, on the belief that we are all friendly, invest together often, are thankful of everyone’s help, and want everyone to get the chance to participate in the upside.
5. Being useful, friendly, and present to the CEO increases your chance that you’ll get pro rata rights. Or you may get the chance to put more money in subsequent rounds even if you don’t have pro rata rights.
6. A more direct note to Maneesh’s question: Convertible notes do not guarantee pro rata rights of any sort in the next round. Even if you put those terms in, rarely do those terms express themselves in the next round since they tend to be subject to the new investor’s negotiations. I have rarely seen convertible note terms beyond interest rate accrual get honored. Even during acquisition, any kind of terms that award investors a multiple of the investment may not even get honored.
This is why Convertible Notes are not investor friendly at all, despite the fact that they are the dominant investment structure out there today.
So more money always talks, and smaller amounts don’t give you much negotiating power, nor your pro rata rights, and this is why you must strive to move up the value chain as an investor, angel or otherwise. That can be hard if your resources aren’t enough where you can come up with that much money.
HOWEVER, I still believe that if more angels spoke up, then potentially we would, as a group, have more ability to obtain pro rata rights for all involved and not just “Major Investors”. This is worth going out to angels and getting them more educated on why pro rata investing is important and why they should ask for those rights and walk away when they don’t get them.
Still, investing in your pro rata for as long as your resources can enable you to will allow you to maximize your portion of future success in a startup.
More on Pro Rata Investing as an Angel
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