How to handle existing investors in new rounds

When you raise new money, your existing investors don't go anywhere. New investors will definitely talk to them and see how they behave. That is why you need to work with your existing investors early and honestly.

First, let's look at their rights. The main one is called pro rata. It is the right to invest enough money in a new round to keep their stake in the company. For example, an investor owns 10% of the company. You issue new shares for new investors, and the investor's stake shrinks. If they have pro rata rights, they can buy more shares and get back to their 10%. The amount is easy to calculate: their stake is multiplied by the size of the new round.

The participation of existing investors tells new ones a lot. If they invest again, it is a sign of confidence: “We know the company from the inside and believe in it.” But it can also work the other way. Some funds think: if the existing investors had to top up their stakes, perhaps outside investors didn't want to invest. That is why it matters how exactly the existing investors participate.

Now, about who will lead the round. Chris Dixon, a venture investor and partner at a16z, describes a common situation. You offer your existing investors the chance to lead the new round, but they hesitate and advise you to test the market first. You find new investors, and they offer good terms. And suddenly your existing investors are very keen to participate. Dixon calls this the “nightclub effect”: as long as no one else is interested, you don't seem all that attractive, but as soon as someone starts courting you, the interest appears immediately.

Existing investors then have three options. They can lead the round themselves, but then it looks as if you used the new investors only to apply pressure. They can take their pro rata share, but the new lead often needs 15–20% of the company, and there isn't enough room. Or they can invest less, but funds don't like that, because they see pro rata as a right they have paid for. Dixon advises agreeing with existing investors in advance: either they lead the round themselves, or they make way for a suitable new investor.

Here is what to do in practice. Calculate each investor's pro rata before negotiations begin, so you understand how much room will be left for new investors. Keep track of how many there are: by Series B there are sometimes 15–20 such investors, and they compete for a small part of the round. If you need money for a short time, a bridge round from existing investors is an option. It looks confident if there is a clear goal behind it, not just a wish to “hold out a little longer.”

And finally, share news with your existing investors first, before others hear about it. A person who has been warned in advance is more likely to become an ally than a problem.

Sources:

1. Chris Dixon (a16z) — Inside versus outside financings: the nightclub effect
2. Eqvista — Pro Rata Rights in Startups
3. CRV — What Are Pro Rata Rights? A Guide for Startup Founders
4. Angel Investors Network — Pro Rata Rights in Venture Rounds and How to Negotiate and Protect Your Pro-Rata Rights
5. VC Beast — Extension Rounds: When to Bridge and How to Structure