What is a Pay to Play Provision?

Pay-To-Play-Provision

Getting investors is critical for many startups. One tool that can encourage investors to continue to participate in funding is called a “pay to play provision.” This is a relatively new provision popularized since the beginning of the 21st century. While the provision may seem harsh to some, many investors will agree to it, which can significantly help support a new enterprise.

A pay to play provision mandates that an investor must continue to pay (keep contributing to financing) in order to continue to play (avoid having preferred stock convert into common stock). This can be highly beneficial, as investors will agree from the beginning of the investment to continue to support the company through its lifecycle. They know from the start if they do not continue their financing support, they risk losing all rights stemming from their preferred stock.

This provision often means that if some prior investors continue their investments in future rounds, other prior investors will be encouraged and incentivized to do the same. Otherwise, their stock and share of the company will get diluted. This sets out a type of rules of engagement for all investors from the initial investment. The provision dictates the differing benefits for participating and non-participating investors, ensuring that only investors who continue to participate and who remain committed to the company have preferred stock and the associated rights.

Is Venture Capital Funding Right for Your Startup?

There are different options for funding for new businesses, including traditional loans, angel investors, crowdfunding, and venture capital. While getting the right investors in a venture capital campaign can be challenging at times, it can be highly beneficial for the right startups. You have to make sure you are willing to give up the related equity in your company in exchange for these investments.

If you are interested in seeking venture capital, you should always contact a skilled startup attorney who can guide you through the process. First, you must have a solid and persuasive business plan to submit to potential investors or firms. The investor will certainly perform due diligence, so your business plan should always accurately and honestly reflect the state of the company, its goals, and realistic projections.

When an investor agrees to participate, they commonly make investments in rounds. This is where the pay to play provision comes in – to incentivize an investor to continue to participate in future rounds of investments. This entire process can be confusing to a new company owner and it is wise to seek counsel from a knowledgeable legal professional who understands the financing options for your startup.

Find Out how Our San Jose Startup Law Firm Can Help

At Startup Company Counsel, our California startup attorneys can assist with every aspect of your new venture – from funding to entity formation to compliance, and much more. We are committed to helping new startups succeed and can handle every legal aspect of your business. To get started and schedule a consultation, please call 408-441-7555 or contact us online today.

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