They stipulate that if necessary funds can’t be raised from new investors, the company’s current investors will need to invest funds in the company. The investment required depends on the investor’s percentage of ownership.
Essentially, pay-to-play requires investors to be committed for the long-term, often contributing to repeated rounds of investment. The practice of pay-to-play was quite common in the 2000s, after the dot-com bubble burst.
What happens if investors can’t afford to contribute?
Investors who can’t (or won’t) contribute will have their preferred shares converted to common stock or another type of equity with fewer rights.
This is why would-be investors should be cautious about pay-to-play clauses in contracts. While pay-to-play can be an advantage, as it can protect the company and benefit investors, it’s important to carefully weigh up the pros and cons of each particular deal.
What types of companies use pay-to-play?
Pay-to-play clauses are relatively rare, with only around 5% of deals using them. However, they are more common in the energy industry. They are also used more frequently by unicorn companies (privately-owned startups with a value over $1B). Generally, pay-to-play clauses are used by companies that are in a strong bargaining position.
How else is pay-to-play used in finance?
The term “pay-to-play” can also be used in a political sense. This is when a company makes a donation or gift to a politician (or candidate) in the hope of receiving business from their municipalities in return.
Some states have regulations restricting campaign contributions from companies that are seeking government contracts — and there is increasing campaigning for more laws on this.