What are pro rata rights?

To understand pro rata rights we have to first understand how dilution works. Say you invest $100,000 in a startup at a $1,000,000 valuation thereby owning 10% of the company with 100,000 shares at $1 each. The founders own the remaining 90% and 900,000 shares.

Let's say they raise their next round from a new investor(A) at a $2M valuation and give away an additional 10% equity for 200K.

Now they will create 111k additional shares so that A owns 10%(111,111K/1.11M)). The total outstanding shares is now 1.11M shares and your ownership is 100,000/1,111,111 = 9.0%. Your equity is diluted by the same percent that is being given away at the next round.

You now own less of the company, but your shares are valued at 9.0% of 2M which is $180,000. Pro rata rights give you the ability to maintain your ownership percentage so when the startup raises the next round they have to "allow" you to contribute more funds at the new(2M) valuation so you can keep your ownership at 10%(the initial ownership).

Investing money in subsequent rounds is called follow on and is generally good practice. The further the startup goes the better the chances of success. Once venture capital money flows in the chances of success rise substantially although its still high risk with the best VCs now returning any money on 50% of their investments.

Dilution can be tricky to understand and it took me a while, feel free to reply to this email with any questions. Things get a little bit more complicated with pre and post money valuations but I've kept it as simple as I can for now. 

Thanks for reading,
Rishad