Most term sheets will include a right for the investors to buy more shares if the company raises another round of funding. This is basically the flip side of the pay-to-play provision. Generally, the investors are allowed to participate in the new financing up to their share of the equity ownership of the company. So, if investors own 20% of the company, they can buy 20% of the stock offered in the next financing.
While this might seem like a good thing-who wouldn't want the original investors in the next deal?-it isn't always best for the company. In future rounds, especially up-rounds where the company has a lot of interest from investors, the new investors will want to purchase the entire round, and won't want to let the original investors participate. This becomes a balancing act between getting the best terms on the next financing and not pissing off the people who took a risk on you at the beginning. A Pro-Rata provision can lay the groundwork for striking this balance.
Founders should try to limit the right of investors to purchase into the next raise, so that they don't restrict the company's ability to raise new capital. Setting reasonable limits will give you a good justification for limiting future participation to the agreed-upon pro rata, while giving the original investors the ability to stay on board. Brad Feld suggests two tips for negotiating this provision:
1x Pro Rata. The typical participation provision allows
an investor to buy a portion of the next round equal to its current
ownership of the company. This is one-times the investors pro rata
interest in the company (or "1x"). If investors own 20% of the
company before the new raise, they should only be allowed to
purchase 20% of the new raise, and not more.
Limit it to Major Investors. Major Investors are investors
who purchased a certain percentage of the original round. Around
10% is a common cut off for being considered a major investor. If
the company has a few shareholders with less than the threshold,
consider restricting the right to participate to the major
investors.
//www.feld.com/wp/archives/2005/06/term-sheet-right-of-first-refusal.html