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Pay to play is a provision in stock financing agreements that requires investors to participate in subsequent share offerings to maintain their interest in the company and protect against dilution. Failure to participate may result in loss of benefits and conversion of preferred stock to common stock.
Pay to play is a term used in a number of stock financing situations and often has to do with rights and privileges extended to investors as a result of their financial interest in a particular company. Provisions of this type are normally outlined in the issuing company’s articles of incorporation, as well as in the terms that are defined in the share purchase agreements connected to the first purchases made by the shareholders. As part of the agreement, investors who hold certain types of shares are required to participate in any share offerings that take place after the completion of your initial investment. In the event that the investor chooses not to participate in one of these subsequent offers, some benefits associated with the pay to play arrangement are withdrawn and usually cannot be reclaimed.
One of the most common strategies associated with a pay to play clause in a stock purchase is for the investor to be protected against the possibility that the value of his interest in the company will be diluted as additional shares are offered on the market. Since the provision requires the shareholder to participate in new stock offerings, and preference is often given to such participation, the ability to maintain a degree or percentage interest in the company is ensured. This is sometimes referred to as dilution protection, as the pay to play allows the degree of interest in the company to be maintained over time, which is often central to the long-term strategies of major investors.
In the event that a shareholder chooses not to exercise this pay to play privilege, protection from any dilution of the percentage shareholding in the company is usually lost. Thereafter, there is no automatic preference accorded to the investor in terms of participation in new share offerings. Should he wish to purchase further shares, he may only do so once the shares have been made available on the stock exchange, and at the current market price.
Because pay to play is often associated with preferred stock, there is also the possibility that a decision not to participate in subsequent stock offerings will trigger a conversion of preferred stock into common stock. This means that investors who experiment with the conversion no longer have access to the fixed dividend offered by preferred stock. Furthermore, shareholders no longer have a privileged status in case the company is forced to go through liquidation of its assets in the future.
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