Pro-Rata Right entitles an investor to continue to participate in subsequent rounds of funding. It ensures that they can retain their initial level of percentage ownership in a company. Investors are not always granted and are not able to reliably pursue pro-rata rights. For rounds, bigger investors usually, get these rights.
The pro-rata right is not an obligation. Hence its holder might exercise it at their discretion.
HOW DOES PRO-RATA RIGHT WORK?
The idea of this right is primarily related to the concept of dilution. Each new round of equity financing implies the issuance of new shares. Dilution of the equity stake percentage of current shareholders occurs at this issuance. Hence on a percentage basis, the existing shareholders lose part of their voting power.
To prevent such a scenario, the investors can ask a company to include a provision that grants them pro-rata rights. The investor with these right is thus able to retain the portion of their equity stake. They also retain voting power.
Some investors with pro-rata rights may opt not to use their option to invest in the next rounds of financing. Unsatisfactory performance or development of a company might lead to the withdrawal of rights. Significant additional investments required for the preservation of the initial ownership percentage is another cause.
Besides, in some cases, investors do not receive rights. Some companies opt to grant such rights to worthy investors who have made a significant impact on the business.
Investors who invest in an early round of financing are usually given or offered pro-rata benefits. For Example, suppose an investor with these rights initially acquired a 15% equity stake in a company. In the case of pro-rata, they have the potential to spend more to retain a 15 per cent interest at the next round of the business financing.