Back to Blog

Should Your Fundraising Deal Include a Pay-To-Play Provision?


There is no definitive answer when deciding whether to include a pay-to-play provision for potential investors, as it really depends on the circumstances of the company seeking funding. As with other possible stock options, the pay-to-play provision has several advantages and disadvantages. The thing is that companies with evident potential are far more likely to entice an investor to submit to this sort of provision given that it basically locks them into additional funding down the road. However, at the same time, it is often the companies whose future is rather uncertain that want this provision included to protect the company during down rounds or times of financial trouble. Irrespective of these competing realities, here are the main pros and cons of the pay-to-play provision:

Pro: It Ensures Future Funding

With a pay-to-play provision, investors are basically agreeing to participate in future funding rounds on a pro rata basis. In the event that the investor elects not to participate in this manner, that investor’s stock is converted into common stock or some kind of shadow preferred stock. In addition, these investors usually forfeit any preferential rights they had previously negotiated, such as anti-dilution protection or special voting rights. Thus, the pay-to-play provision clearly encourages investors to honor their agreement to participate in those future fundings to avoid such negative consequences. This investment strategy is meant to serve as an incentive to investors, thereby assuring company leaders that at least some of the pay-to-play investors will participate in subsequent financings when the need arises.

Con: It Deters Early Investors

Of course, given that this provision essentially strong-arms investors into agreeing to participate in future fundraising efforts, something that often occurs because the company is facing financial turmoil or is even engaged in a down round, this does not exactly inspire investor excitement or confidence. As a result, even mentioning the desire to include this provision may deter otherwise interested investors from making an initial investment. In some cases, it may be possible to limit the pay-to-play provision to some extent, but it is likely still a risky investment from any conservative investor’s standpoint.

Pro: It Offers Protection in a Down Round

As mentioned, one of the reasons that the pay-to-play provision often comes into force is due to the company’s need to engage in a down round. Any down round, irrespective of the terms and reason, will likely be regarded rather negatively by investors. Thus, the provision clearly offers the company in need of capital with some protection, ensuring that it receives the funds it needs and perhaps helps to avoid the triggering of other negative consequences generally associated with the stock price decline.

Con: Once Triggered, the Benefits are Usually Gone

This is where the pay-to-play is particularly risky. Investors who commit to this and then choose not to participate in a future financing despite agreeing to the provision, thereby allowing for their stock to convert, will generally have even less of an incentive to retain their investment in the business. The investors may seek to cut their losses and sell their remaining interests at an even lower price, further undercutting the company’s value and essentially negating the purpose and benefit of the pay-to-play provision.

Download the Guide to Secure File Sharing Software