Pay-to-Play Provisions

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Updated September 13, 2022
Raising Venture Capital

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Definition A pay-to-play provision in a term sheet requires investors to participate, at the company’s request, in subsequent financing rounds on a pro rata basis. If an investor does not participate when requested, they face consequences that can range from losing some privileges like anti-dilution protections to having their preferred stock wholesale converted to common stock.

Pay-to-play provisions are extremely rare in technology investment deals. But they are absolutely common in biotechnology or life sciences deals because those types of companies require such a large amount of capital to get a product to market. Early investors in biotechnology or life sciences companies need to be prepared to pony up cash in future financings and go the distance.

Learn more from the Startup Company Lawyer blog post, “What is a pay to play provision?

Registration Rights

Definition A registration rights provision in a term sheet allows an investor to require a company to register the investor’s shares with the SEC when certain conditions are met, ensuring that the investor has the opportunity to sell their shares in the public market. Commonly listed conditions are: a certain period of time passing after the initial investment or an IPO; the company qualifying for a simplified registration; and/or the company registering other shares for public sale.* Registration rights are desirable to investors because the SEC’s Rule 144 limits the sale of a company’s stock to 1% of the total outstanding shares in a three-month period but only applies to unregistered stock.*

Registering shares is usually seen as a good thing for both a company’s management and investors. When a company goes public, large investors like Fidelity and T. Rowe Price may buy up large positions and hold them. This means the company’s stock is not widely available for purchase on the open market and can lead to volatility. When a large investor is able to sell a meaningful position after the lockup period, this increases the number of shares available for trading, which can reduce volatility. Again, good for everybody.

Usually, if big investors want liquidity near an IPO, there will be a separate conversation between management and investors as to how to make this happen outside of registration rights.

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