When diving into the world of startup investing, you'll often come across the term "what is pro rata, how to calculate pro rata"—especially when reviewing term sheets or navigating follow-on rounds. But what does pro rata mean, and why is it significant for angel investors? Let’s break it down.
What is Pro Rata?
Pro rata is a Latin term that means "in proportion". In finance and investing, it refers to the proportional allocation of something—typically rights, dividends, or ownership—based on an investor’s existing stake.
In the context of startup investing:
A pro rata right gives an investor the option to maintain their percentage ownership in a company by participating in future funding rounds. This is crucial when the startup grows and raises more capital.
Example:
If you own 5% of a company and it raises another funding round, your pro rata right allows you to invest enough in the new round to maintain your 5% ownership, preventing dilution.
Why Pro Rata Rights Matter for Angel Investors
Preserve Ownership: As companies grow and raise more capital, early investors without pro rata rights can see their ownership diluted.
Upside Potential: If a company is performing well, participating in future rounds allows you to double down on winners.
Signaling Value: Exercising your pro rata rights can send positive signals to other investors and founders.
How to Calculate Pro Rata Investment
Let’s say you’re an angel investor with a 3% stake in a startup. The company is raising a new round worth $2 million.
Pro Rata Investment Formula:
Pro Rata Investment = Ownership % × New Round Size
So in this case:
3% × $2,000,000 = $60,000
This means you’d need to invest $60,000 in the new round to maintain your 3% ownership.
A Real-World Use Case for Angel Investors
Imagine investing $25,000 for 2.5% in a pre-seed round. The startup later raises a $5 million Series A. If you have pro rata rights, you can invest $125,000 (2.5% of $5M) to keep your stake steady—now at a much higher valuation.
Pro Rata vs. Super Pro Rata
While pro rata helps you maintain ownership, super pro rata gives you the option to increase your stake. Some angel investors negotiate for this if they bring strategic value early on.
Final Thoughts
Understanding and negotiating pro rata rights is vital for angel investors aiming to maximize returns and avoid dilution in fast-growing startups. At Angel School, we empower you with the knowledge and tools to make smart investment decisions—and knowing your pro rata math is a great place to start.
