Posts Tagged ‘pro-rata rights’

Pro-rata Rights For Angels

Joanne Wilson (aka Gotham Gal) has an outstanding post today titled Pro-rata rights. In it she makes two important points about angel investing.

  1. She won’t do a deal if the legal documents aren’t good.
  2. She won’t do a deal if she doesn’t get pro-rata rights.

She then goes on to discuss a thing that happens continually in VC deals. When VCs invest in rounds, they set a threshold for “major investors” and, if you aren’t a major investor, you lose your pro-rata rights. In Joanne’s case, she hates this because her angel strategy is to maintain her pro-rata through the life of the company.

As a VC investor, I always insist on pro-rata rights. I did also when I invested as an angel, although my angel strategy was to invest in only the first two rounds. As an angel, I’d do the seed round, then one more round if needed, and then I’d stop. Occasionally I’d do a later round, especially if my investment was needed for positive signaling, or if it was a down round because of some circumstance, but I still believed in the company.

I know many VC investors who aggressively cut angels out of the pro-rata rights in later rounds. I’ve ended up deals where that’s in the docs, almost always driven by someone else. I’m generally indifferent – I’m delighted to have angels continue to participate if they want, and not if they don’t (my personal syndication agnostic view that I’ve talked about on Feld Thoughts many times.)

As an angel, it’s important to know the lay of the land and how it coud impact you in the future. Joanne does an awesome job of laying to the issue of pro-rata rights in this post – go read it now.

Convertible Debt – Other Terms

In today’s episode of our convertible debt series, we discussion a few other terms that come into play with a transaction.

Interest Rate: We believe interest rates on convertible debt should be as low as possible. This isn’t bank debt and the funders are being fairly compensated through the use of whatever type of discount has been negotiated. If you are an entrepreneur, check out what the Applicable Federal Rates (AFRs) are to see the lowest legally allowable interest rates are and bump them up just a little bit (for volatility) and suggest whatever that number is. Typically we see an interest rate between 7% and 10%.

Pro-Rata Rights: This term allows debt holders to participate pro-ratably in a future financing. Since many times the dollars amounts are low / lower in a convertible debt deal, investors may ask for “super pro-rata” rights. For instance, if an investor gave a company $500,000 in a convertible debt deal and the company later raises $7,000,000, the investor’s pro-rata investment rights wouldn’t allow them to purchase a large portion of the next round. Sometimes investors will ask for pro-rata rights that are a multiple of their investment. In this case the investor may ask for two to four times their amount. While pro-rata rights are pretty typical, if you have people asking for super pro-rata rights, or a specific portion of the next financing, you should be careful as this will likely limit your long term financing options.

Liquidation Preferences: Every now and then you’ll see a liquidation preference in a convertible debt deal. It works the same as it does in a preferred stock deal – the investors get their money back first, or a multiple of their money back first, before any proceeds are distributed to anyone else. This usually happens in the case when a company is struggling to raise capital and current investors offer a convertible debt (also called a bridge loan) deal to the company. Back in the good old days usury laws prevented such terms, but in most states this is not an issue and allow the investors to not only have the security of holding debt, but the upside of preferred stock should a liquidation event occur.

Other Terms: If you see other terms in a proposed deal outside of these, we’d guess that they are unique to your situation, as the ones we’ve discussed should cover the vast majority of debt transactions.