Pay-to-Play

Pay-to-Play, in the context of stockholders owning stock in a corporation, is a term that refers to the requirement that stockholders continue to invest in future stock issuances of the corporation, to avoid losing certain benefits of their stock positions. For instance, if a venture capitalist (VC) takes a preferred stock position in a corporation, and the preferred stock is subject to pay-to-play terms, then, if the corporation decides to issue additional shares, and the VC decides not to buy his or her pro rata portion of those additional shares, then all, or a part of, the VC’s preferred stock position may be converted over to a common stock position. Pay-to-play provisions ensure a company that its current investors will continue to invest in future rounds by giving those investors disincentives for not investing in those future rounds. Such provisions weed out those investors who do not want to continue fully supporting the company during its subsequent capital raise, by demoting those investors to common stockholders. Investors don’t like common stock, for the most part. The reason is that common stock doesn’t provide its holders with certain benefits, such as anti-dilution rights, liquidation preferences, and dividend preferences. That said, there are no statutory rules that define the terms of common stock and preferred stock. The terms result from industry standards and commonly accepted practices.