Featured Article

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

Alpha Partners, SignalRank and now SaaS Ventures help seed VCs pay for shares when big VCs try to price — or push — them out

Comment

Image Credits: Say-Cheese / Getty Images

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

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

The problem is that in later rounds, the new lead investor will usually get its preferred allocation. Meanwhile, other new investors try to get what they can while existing investors have to pony up whatever the lead has agreed to pay per share if they want to exercise their pro rata rights. 

And, often, the new investors would prefer to squeeze pro rata investors out of the round altogether and take more for themselves. Meanwhile, founders want to cap the total chunk of their company they will sell in the round.

“It’s pretty common that a downstream investor will want to take as much of the round as they want, and will sometimes tell the founder they need an allocation that’s so large, it wouldn’t leave room for pro rata rights — essentially telling the founder to ask earlier investors if they would willingly waive their pro rata rights,” Edwards told TechCrunch. 

Earlier investors often have to rely on the founder “going to bat for us and pushing back on that request,” which will only happen if the investors provide enough value that they feel comfortable negotiating on the earlier investors’ behalf, he said.

Securing capital to stay in the game

Sometimes venture capitalists don’t choose to exercise their pro rata rights. While they obviously might pass on buying more shares in a struggling startup, they are often forced to pass up buying more of their winners, too, because they can’t afford them. 

Between 2020 and 2022 — during the VC investing frenzy years, for example — Edwards saw a lot of early-stage funds decline to exercise pro rata on later-stage rounds due to what he called “eye-popping valuations.”

Jesse Bloom, SaaS Ventures
Jesse Bloom, partner at SaaS Ventures.
Image Credits: SaaS Ventures /

Indeed, new investors in later rounds often run bigger funds than seed investors and can pay more per share, making it tough for early-stage investors and smaller funds to keep participating in later rounds.

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

“When, for example, Sequoia invests in a Series A, other existing investors can participate,” SaaS Ventures partner Jesse Bloom told TechCrunch. “However, if you want to get in on the Series B, you have to be invited by Sequoia, the founder or were involved in the Series A. My job is to hear from my network that it is happening and find Series A investors and offer to stake them in their pro rata. I give them money to invest in their pro rata, and I get 10% of the carried interest.”

Most, if not all, of the names on the list of top-tier VC firms Bloom monitors for later-stage deals are those you recognize, from Andreessen Horowitz to Insight Partners to Valor Equity Partners.

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

That’s another reason why he only invests in deals led by a list of the top 25 VC funds listed on its website, Bloom said. “We believe access beats diligence in the long run in later-stage venture capital and will do whatever it takes to gain access to deals led 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 before SaaS Ventures leaders Collin Gutman, Brian Gaister and Seth Shuldiner hired him to raise a fund for them.

He has now closed a new fund for SaaS Ventures with $24 million in capital commitments to invest in those pro rata opportunities. The new fund limited partnership is anchored by Pennington Partners, which manages multiple family offices. It is also backed by registered investment advisors who understand the advantages had by the large venture capital firms but are often unable to get in at the higher ticket sizes, Bloom said.

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

Pro rata boom

Bloom’s not alone in finding success for pro rata-targeted funds. Keith Teare’s SignalRank raises funds on a quarterly basis, including a $33 million one from January, according to an SEC filing. Alpha is also raising a new fund to target pro rata, according to Steve Brotman, managing partner at Alpha Partners. The firm secured just over $125 million in capital commitments, and he expects to close at the end of July with over $150 million.

For many of the early investors on a company’s cap table, which are smaller than more established growth funds, pro rata is traditionally one of the only ways to gain access to these highest quality later-stage rounds, Bloom said. Similarly for founders, this type of deal supports their existing investors.

“We are essentially LPs supporting the pro-rata rights of existing investors,” he said. “If a company is destined to IPO, at some point down the line, pro-rata will become too large for existing investors to fill and they get left behind, so I give them fast and easy capital to continue investing in their winners.”

As Root VC’s Edwards mentioned, two years ago, investors weren’t rushing to make pro rata deals. Today, that seems to be a different story. The pro rata game is heating up, according to Bloom and Brotman, who say much of this is coming from fewer deals being done at later stages, so there is more of a challenge getting 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, which is just 11.3% of the $81.8 billion raised in the 2023 market, according to PitchBook-NVCA Venture Monitor

Steve Brotman, Alpha Partners
Steve Brotman, managing partner at Alpha Partners
Image Credits: Alpha Partners /

Investors said this leaves an abnormally high number of VCs unable to fund their pro rata rights. In fact, Brotman says as much as 95% of the time, investors aren’t doing their pro rata. 

“Pro rata rights and opportunity funds really boomed out in 2021 and 2022, then in 2023, there started to be a downward trend,” he told TechCrunch. “In 2024, very few funds are being raised by small funds. LPs are figuring this out. They did a lot of co-investing in 2022, and 2021 and got their asses burned, honestly, because they rushed in at massive valuations.”

He likened it to playing the card game Blackjack and if you have a certain hand, you can double down on your bet, depending on what the dealer is showing. “If you don’t double down when you can, the house wins. The same is true in venture capital, but no one’s bothered to talk about it,” he told TechCrunch. 

Well-known 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 how if he had utilized his pro rata follow-on rights in his first fund, he could have tripled the returns, which already achieved a 5x return. So why didn’t he?

“Well, back in that day, you were trying to use your 100 swings at bat, or in the case of this $10 million, 109 swings, to hit one outlier based on the Power Law,” Calacanis said. In this case, the “Power Law” is where one single investment yields returns larger than all other investments combined.

Among institutions and family offices, risk and duration are affected 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 — more like three to six years, he said.

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

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

More TechCrunch

Rocket Lab surpassed $100 million in quarterly revenue for the first time, a 71% increase from the same quarter of last year. This is just one of several shiny accomplishments…

Rocket Lab’s sunny outlook bodes well for future constellation plans 

In 1996, two companies, Patersons HR and Payroll Solutions, formed a venture called CloudPay to provide payroll and payments services to enterprise clients. CloudPay grew quietly over the next several…

CloudPay, a payroll services provider, lands $120M in new funding

The vulnerabilities allowed one security researcher to peek inside the leak sites without having to log in.

Security bugs in ransomware leak sites helped save six companies from paying hefty ransoms

Featured Article

A comprehensive list of 2024 tech layoffs

The tech layoff wave is still going strong in 2024. Following significant workforce reductions in 2022 and 2023, this year has already seen 60,000 job cuts across 254 companies, according to independent layoffs tracker Layoffs.fyi. Companies like Tesla, Amazon, Google, TikTok, Snap and Microsoft have conducted sizable layoffs in the…

A comprehensive list of 2024 tech layoffs

A new “beta rabbit” mode adds some conversational AI chops to the Rabbit r1, particularly in more complex or multi-step instructions.

Rabbit’s r1 refines chats and timers, but its app-using ‘action model’ is still MIA

Los Angeles is notorious for its back-to-back traffic. Three events that promise to bring in millions of spectators from around the world — the 2026 World Cup, the Super Bowl…

Archer to set up air taxi network in LA by 2026 ahead of World Cup

Featured Article

Amazon is fumbling in India

Amazon’s decision to overlook quick-commerce in India is now looking like a significant misstep.

Amazon is fumbling in India

OpenAI’s GPT-4o, the generative AI model that powers the recently launched alpha of Advanced Voice Mode in ChatGPT, is the company’s first trained on voice as well as text and…

OpenAI finds that GPT-4o does some truly bizarre stuff sometimes

On Thursday, Box filled in a missing piece on its AI platform when it bought automated metadata extracting startup, Alphamoon.

Box adds crucial piece to its AI platform with Alphamoon acquisition

OpenAI has announced a new appointment to its board of directors: Zico Kolter. Kolter, a professor and director of the machine learning department at Carnegie Mellon, predominantly focuses his research…

OpenAI adds a Carnegie Mellon professor to its board of directors

Count Spotify and Epic Games among the Apple critics who are not happy with the iPhone maker’s newly revised compliance plan for the European Union’s Digital Markets Act (DMA). Shortly…

Spotify and Epic Games call Apple’s revised DMA compliance plan ‘confusing,’ ‘illegal’ and ‘unacceptable’

Thursday seeks to shake up conventional online dating in a crowded market. The app, which recently expanded to San Francisco, fosters intentional dating by restricting user access to Thursdays. At…

Thursday, the dating app that you can use only on Thursdays, expands to San Francisco

AI companies are gobbling up investor money and securing sky-high valuations early in their life cycle. This dynamic has many calling the AI industry a bubble. Nick Frosst, a co-founder…

Cohere co-founder Nick Frosst thinks everyone needs to be more realistic about what AI can and cannot do

Instagram is rolling out the ability for users to add up to 20 photos or videos to their feed carousels, as the platform embraces the trend of “photo dumps.” Back…

Instagram is embracing the ‘photo dump’

Welcome back to TechCrunch Mobility — your central hub for news and insights on the future of transportation. Sign up here for free — just click TechCrunch Mobility! Anyone paying…

Lyft ‘opens a can of whoop ass’ on surge pricing, Tesla’s Dojo explained and Saudi Arabia pumps $1.5B into Lucid

Flint Capital just closed its third fund at $160 million. Its has a unique strategy for finding its limited partner investors. 

Flint Capital raises a $160M through an unusual fund-raising strategy

Earlier this week it emerged that the DPC had instigated court proceedings seeking an injunction against X over the data processing without consent.

Elon Musk’s X agrees to pause EU data processing for training Grok

During testing, Google DeepMind’s table tennis bot was able to beat all of the beginner-level players it faced.

Google DeepMind develops a ‘solidly amateur’ table tennis robot

The X account announced that its Premium+ subscription would now be “fully” ad-free, leading some to question how this change would affect creator earnings.

As X sues advertisers over boycott, the app ditches all ads from its top subscription tier

Apple has further revised its compliance plan for the European Union’s Digital Markets Act (DMA) rulebook, which, since March, has forced it to give iOS developers more freedom over how…

Apple revises DMA compliance for App Store link-outs, applying fewer restrictions and a new fee structure

The rise of neobanks has been fascinating to witness, as a number of companies in recent years have grown from merely challenging traditional banks to being massive players in and…

Chime and Dave execs are coming to TechCrunch Disrupt 2024

If you visited the Wikipedia website on mobile this week, you might have seen a pop-up indicating that dark mode is ready for prime time.

How to enable Wikipedia’s dark mode

The home security company says attackers accessed databases containing customer home addresses, email addresses, and phone numbers.

Home security giant ADT says it was hacked

The Looking Glass Pro has a 6-inch display and a foldable base. It shows spatial images like those created with the Apple Vision Pro and iPhone 15 Pro.

Looking Glass’ new lineup includes a $300 phone-sized holographic display

TikTok’s latest offering is capitalizing on the app’s ability to serve as a discovery engine for other media — something its users already take advantage of by sharing short clips…

TikTok partners with Warner Bros. to become a discovery engine for TV and movies

Cocoon is a new startup built on the belief that greener steel production and the creation of concrete slag doesn’t have to be an either/or proposition.

Cocoon is transforming steel production runoff into a greener cement alternative

SoundHound, an AI company that makes voice interface tech used by car companies, restaurants and tech firms, is doubling down on enterprise services by playing consolidator in a crowded market.…

SoundHound acquires Amelia AI for $80M after it raised $189M+

Seeking mental health support is a complex process, but some founders believe that using AI to formalize techniques like cognitive behavioral therapy (CBT) can help folks who might not have…

Feeling Great’s new therapy app translates its psychiatrist co-founder’s experience into AI

The U.K.’s antitrust regulator has confirmed that it’s carrying out a formal antitrust investigation into Amazon’s ties with Anthropic, after Amazon recently completed a $4 billion investment into the AI startup.…

UK launches formal probe into Amazon’s ties with AI startup Anthropic

Bardeen has raised $3M to build its platform that uses a natural language interface to automate repetitive knowledge work.

AI business agent startup Bardeen pulls in strategic investment from Dropbox and HubSpot