It’s time to hold investors accountable and abolish pro-rata

VC has changed a lot since I was pounding the pavement on Sand Hill Road as a young entrepreneur in the late ’90s.

Capital was hard to come by, and founders had to practically beg VCs to back their company. Our options for funding were limited to a handful of blue-chip firms and networks of successful angels. Two decades later, there is more money flowing from more sources than ever, and equity capital has become a commodity.

In today’s market, it’s not uncommon to hear the sentiment that VCs have to work to sell their money. We’re now in the era of “value-add venture capital,” where investors need to show founders that they will do more for them than merely cut a check. It’s a change of power, and the sales pitch these VCs give to founders is that they’ll be true partners who will be with them every step of the way.

But all too often, founders discover the hard way that these value-add services have a short expiration date.

When we polled founders across our portfolio, we found that even the best-intentioned investors rarely provide much value-add beyond 90 days from when they signed the term sheet. At that point, the investor’s engagement is limited to their attendance at the quarterly board meeting — and that’s the lead investor.

While many VCs may think of themselves as financiers, they ultimately provide a service to their founders.

Many of the other participants provide no additional value beyond their check besides the occasional introduction. Based on what our founders told us, a solid 20% of cap table contributors don’t even help their founders make strategic connections. They throw their money in the pot and disappear.

In a world where investor money flows freely, the VCs that don’t provide value-add are dead weight. Yet, they invariably invoke their contractually negotiated pro-rata rights when it comes time to raise a new round. Their mere presence on the cap table disincentivizes other VCs from working harder for their founders.

After all, why should they do more for their founders than their peers if they both are guaranteed to keep a spot at the table?

“This is the way it’s always worked” isn’t a good excuse. It’s time for founders to hold their investors to a higher standard and insist that they provide continuing support as they scale their company. It’s time to abolish traditional pro-rata rights.

In a term sheet, the pro-rata clause guarantees an investor the right to maintain (or increase) their equity stake in the company by investing in future rounds. There are no strings attached, no KPIs that the investor must hit for their founders. Pro-rata rights are simply part of the deal.

In truth, pro-rata is an immense privilege that VCs take for granted. Now that capital is a commodity, founders can and should demand that the right to invest in future rounds is contingent on demonstrating value-add. Think of it as “performance-rata,” a new type of pro-rata granted only to investors that brought more to the partnership than capital.