Seed VCs are turning to new ‘pro rata’ funds that help them compete with larger firms

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Lee Edwards, a partner at Root VC, has a saying at his firm that “per pro rata rights are earned, not given.” This may be a bit of an exaggeration since per pro rata is a term VCs put in their term sheets that gives them the right to purchase more shares in the portfolio company during subsequent funding rounds in order to maintain ownership percentage and avoid dilution.

Still, while these rights are not actually “earned,” they can be expensive. One of the newest trends in VC investing these days are funds dedicated to helping seed VCs exercise their pro rata rights.

The problem is that in the subsequent rounds, the new lead investor usually gets his preferred allocation. Meanwhile, other new investors try to get what they can, while existing investors have to pay the amount fixed by the lead investor per share to exercise their proportionate rights.

And, often, new investors prefer to cut out the proportional investors from this round completely and take more for themselves. Meanwhile, founders may want to limit the total portion of their company they will sell in the round.

“It’s very common that a downstream investor will want to take as much of a round as they can, and will sometimes tell the founder that they want such a large allocation that there won’t be room left for pro-rata rights — basically telling the founder to ask earlier investors if they would voluntarily give up their pro-rata rights,” Edwards told TechCrunch.

He said early investors often have to rely on the founder to “fight for us and get that request back,” which will only happen if the investors offer enough value that they feel comfortable negotiating on the early investors’ behalf.

Securing capital to stay in the game

Sometimes venture capitalists do not want to exercise their pro rata rights. While they can avoid buying more shares in obviously struggling startups, they are often forced to avoid buying more shares in their winners because they cannot afford them.

Between 2020 and 2022 — for example, during the years of the VC investment frenzy — Edwards saw many early-stage funds refuse to invest proportionately in later-stage rounds at what he called “eye-popping valuations.”

Jesse Bloom, SaaS Ventures
Jesse Bloom, Partner at SaaS Ventures.
Image Credit: SaaS Ventures /

In fact, new investors in later rounds often run larger funds than seed investors and can pay more per share, making it harder for early-stage investors and smaller funds to participate in later rounds.

This is where investment firms like Alpha Partners, SignalRank, and now SaaS Ventures come in. All three invest capital at the Series B level and later rounds, in order to support seed-stage and Series A VCs who want to exercise their pro-rata rights.

“For example, when Sequoia invests in a Series A, other existing investors can participate as well,” Jesse Bloom, partner at SaaS Ventures, told TechCrunch. “However, if you want to join the Series B, you must be invited by Sequoia, the founders, or the people involved in the Series A. My job is to hear from my network that this is happening and find the Series A investors and offer them their proportionate stake. I give them the money to invest their proportionate stake, and I get 10% of the carried interest.”

Most, if not all, of the names on the list of top-tier V.C. firms monitored by Bloom for later-stage deals are ones you know, from Andreessen Horowitz to Insight Partners and Valor Equity Partners.

He’s also able to make quick decisions because if a top-tier V.C. fund is leading a deal, he doesn’t need to do as much due diligence, he said, adding, “That’s the only way I can get involved — I’m betting on the unfair advantage of the top guys.”

Bloom said this is another reason he only invests in deals that are driven by a list of the top 25 VC funds listed on his website. “We believe access to later-stage venture capital trumps due diligence in the long run and we will do anything to get access to deals driven by our top funds, even if it means we don’t know as much about the company,” he said.

Bloom previously worked at Alpha Partners, then was hired by SaaS Ventures heads Collin Gutman, Brian Gaster, and Seth Schuldiner to raise a fund that would compete with Alpha.

He has now closed a new fund, SaaS Ventures, with a $24 million capital commitment to invest in those proportional opportunities. The new fund’s limited partnership is run by Pennington Partners, which manages a number of family offices. It’s also backed by registered investment advisors, Bloom said, who understand the benefits of large venture capital firms but are often unable to get involved in higher ticket sizes.

Bloom has already closed five deals, including Apollo.io’s Series D and MaintenX’s Series C, both led by Bain Capital Ventures; Cover Genius’s Series E, led by Spark Capital; and Elasticity’s Series B round, led by Insight Partners.

Proportional bounce

Bloom isn’t the only one finding success with pro rata-targeted funds. According to SEC filings, Keith Teare’s SignalRank is looking for a $33 million fund, which it began raising in January. Alpha is also raising a new fund to target pro rata, according to Steve Brotman, managing partner of Alpha Partners. The firm has secured a little over $125 million in capital commitments, and they expect to close with over $150 million by the end of July.

Bloom said that for many of the early investors on a company’s cap table, because many of them write checks of $1 million to $3 million, pro rata is traditionally the only way they can get into these larger deals. Likewise for founders, this type of deal supports their existing investors.

“We are essentially the LPs of their existing investors, so they can get proportional rights to anti-dilution,” he said. “At some point, the founders will cut off the existing investors, so I give them access to very cheap and quick capital.”

As Root VC’s Edwards pointed out, two years ago, investors weren’t rushing to do proportional deals. Today, it seems to be a different story. The proportional play is heating up, according to Bloom and Brotman, who say a big reason for this is fewer deals being done at later stages, so it’s more challenging to get access to those big-ticket deals.

In the first quarter of 2024, $9.3 billion in capital was raised by VCs across 100 U.S. funds, just 11.3% of the $81.8 billion in capital raised in the 2023 market, according to PitchBook-NVCA Venture Monitor.

Steve Brotman, Alpha Partners
Steve Brotman, Managing Partner, Alpha Partners
Image Credit: Alpha Partners /

Investors said this leaves an unusually large number of VCs unable to fund their pro-rata rights. In fact, Brotman says that in 95% of cases, investors are not exercising their pro-rata rights.

“Pro rata rights and opportunity funds really jumped in 2021 and 2022, then started to trend down in 2023,” he told TechCrunch. “In 2024, there are a lot fewer funds being raised by smaller funds. LPs are realizing that. They co-invested a lot in 2022 and 2021 and, frankly, they lost a lot because they rushed in at a big valuation.”

He compared it to playing the card game blackjack and if you have a certain hand, you can double your bet based on the bet shown by the dealer. “If you don’t double when you can, the house wins. The same is true in venture capital, but no one bothers to talk about it,” he told TechCrunch.

Renowned angel investor Jason Calacanis, founder and CEO of Inside.com and Launch, sat down with Brotman in May for his podcast, “Driving Alpha,” and told Brotman that if he had exercised his pro rata follow-on rights in his first fund, he could have tripled the return, which has already generated a 5x return. So why didn’t he do it?

Calacanis said, “Well, at that point, you were trying to use your 100 swings at bat, or in this $10 million case, 109 swings, to hit an outlier based on the power law.” In this case, the “power law” is where a single investment generates a greater return than all the other investments combined.

Risk and duration are impacting institutions and family offices right now, with duration “really being the killer,” Brotman said. Many of these institutions don’t have 10 to 15 years to prove their worth — but rather three to six years.

Venture capitalists need to double down on their winners and talk to their founders about why it’s important for them to do so. Also, if they can exercise their pro rata rights, they can often stay on the board, which is important for early VCs, Brotman said.

“A big component of being a venture capitalist is being able to be on board your unicorn,” he said. “Even if they’re not on the board, the fact that they’re investing means CEOs will still spend more time with them and respond to their calls.”

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