The Pay to Play Provision: 3 Important Things to Know About Anti-Dilution and Startups

 

The Pay to Play provision in term sheets, includes a review of how Pay-to-Play works, what it means and why venture capitalist use this provision/clause in the term sheet.

To protect your business and any other investors, there are several steps you can take. One of these is the so-called "pay to play" provision. So exactly what is a pay to play provision? This is a provision that will encourage investors to fully participate in the financing of a venture. Typically, it prevents investors from gaining all of the rights and benefits of a venture if they do not participate to the full ratio rate that is outlined in the provision. What does this mean for startup ventures? It can be very beneficial to gaining quality investors as well as protecting those investors. The best way to incorporate this provision is to create an anti-dilution clause. There are three key things to understand about this that can help the venture go further in the long run.

 

#1 Dilution and Anti-Dilution & Pay to Play


Why Investors Care about Pay to Play
There is a big difference between dilution and anti-dilution. For investors this is a way to protect their investment. The clause, when added into the pay to play provision, will prevent them from losing money if the stock prices fall below what they originally paid for them. In other words, it protects them from dilution should the stock prices fall. In the case that the stock prices fall, they will still be guaranteed the price they originally paid for them, therefore not earning any money but also not losing any money. For major investors, this is a very important thing that they look for and this guarantee can result in many more investors for your venture. 

#2 Right of First Offer & Pay to Play


Getting the first purchase choice
With this portion of the provision, the investor is given the right to make the first offer on the business if it were up for sale. No outside parties can make an offer before the investor does for a certain amount of time. This gives them more security as well because they will ahve the first opportunity to jump on the purchase of a business they are already invested in. However, this still protects the seller because they are allowed to accept or reject the offer given by the investor if they want to search for a better deal. Additionally, the seller can return to the investor/buyer at any time if they are unable to find a better deal than that given by the investor. This provides an advantage to both the investor and the business owner. Since they both hold stake in the company, they are required to go through the motions with each other first.

#3 Preemptive Right


The option to purchase more of the business first
This option in the pay to play provision gives the current shareholders or investors in the business the first opportunity to purchase additional shares. This is beneficial because these investors will be able to do this before this option is opened up to the general public. Often, many investors look for a clause like this because if the company is doing well, they want to opportunity to invest in it even more before it gets any bigger. This only happens when there is a seasoned offering and not when shares are being bought and sold between investors. If new shares are being made available entirely, the current investors will get the right to purchase them first. 

 

All of these components of the pay to play provision are very important in attracting quality investors. People who are serious about their investing tactics will take a company seriously if these are added into the provision. Often, they look specifically for these items, the anti-dilution clause, the right of first offer clause, and the preemptive right clause, as a way to protect as well as grow their money. It is not only important to understand what these mean but to also consider them for your venture. The key to getting startup financing and attracting the right investors comes down to how well you appeal to them and speak their language. You want the investors and they want a return on their money. Protect them and your business by adding these clauses to your pay to play provision. 

 

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Learn about Startup Investing and the Pay to Play Provision, with these 10 Tips:

The pay-to-play provision and startups, explained.  

The pay-to-play provision and startups, explained.  

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