What is a right of first offer (i.e., pro rata right)?
Takeaway: A pro-rata right gives investors the option to maintain their ownership percentage in future financings, but in practice these rights are often waived so the company can avoid the burdensome formal notice-and-waiting process. Investors are still frequently offered their pro rata informally.
As your startup grows and raises multiple rounds of financing, each new round dilutes existing stockholders. A pro-rata right—sometimes called a right of first offer—is designed to protect early investors by giving them the contractual right to purchase their share of the new round to maintain their ownership percentage.
How Pro-Rata Rights Work
Pro-rata rights are granted in the company’s Investors’ Rights Agreement and operate as follows:
Notice of a New Financing: Before closing a new round (e.g., a Series B), the company must notify investors who hold pro-rata rights.
The Pro-Rata Calculation: Each investor is told how many shares they can buy to keep their ownership percentage steady.
The Investor’s Option: The investor may exercise the right to purchase those shares at the new round’s price—or decline.
Example:
An investor owns 10% of your company before the Series B.
The company issues 5 million new shares in the Series B.
That investor has the right to buy 500,000 shares to stay at 10%.
Why Pro-Rata Rights Are Often Waived
While pro-rata rights are a standard feature of venture financings, in practice they are frequently waived. The primary reason is administrative: formally honoring the right requires the company to issue legal notices to all investors, wait through the election period, and potentially delay the financing.
Instead, the common practice is:
Informal Pro-Rata Offers: Companies (and their lead investors) will often offer existing investors the chance to take their pro-rata in an informal, cooperative process.
Formal Waiver: Investors sign a waiver of their contractual rights, so the company can avoid the cumbersome notice-and-wait procedure.
This approach streamlines the closing while still allowing supportive investors to participate.
Why They Still Matter
Optionality: Even if waived formally, the right gives investors leverage to request participation in later rounds.
Signal to New Investors: When existing investors do step up and take their pro-rata, it remains a strong signal of confidence.
In reality, pro-rata rights are less about strict legal process and more about ensuring that early investors have the opportunity—if not always the formal contractual mechanism—to continue supporting the company in future rounds.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.