Pay to play is a provision in equity financing that requires investors to participate in subsequent share offerings to maintain their percentage interest in the company and avoid dilution. Failure to participate can result in loss of benefits and conversion of preferred stock to common stock.
Pay to play is a term used in a number of equity financing situations, often having to do with the rights and privileges granted to investors as a result of their financial interest in a given company. Provisions of this type are typically described in the issuing company’s documents, as well as in the terms that are defined in the stock purchase agreements associated with the initial purchases made by shareholders. As part of the agreement, investors who own certain types of shares must participate in any share offerings that take place after their initial investment is complete. In the event that the investor chooses not to participate in one of these subsequent offerings, certain benefits associated with the pay-per-play provision are removed and generally cannot be recovered.
One of the most common strategies associated with a pay to play clause in a stock purchase is the ability for the investor to be protected from the possibility of the value of their interest in the company diluting as additional shares are offered in the future. the market . Since the provision requires the shareholder to participate in new stock offerings, and is often given preference in that participation, the ability to maintain the degree or percentage interest in the company is guaranteed. This is sometimes called dilution protection, as pay-to-play allows interest in the company to be maintained over time, a factor that is often key to the long-term strategies of key investors.
In the event that a shareholder chooses not to exercise this pay-to-play privilege, the protection against possible dilution of the percentage interest in the company is typically lost. Thereafter, there is no automatic preference given to the investor in terms of participation in new share offerings. If he or she wishes to purchase additional shares, it is possible to do so only once the shares become available on an exchange, and at the current market price.
Since 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 to common stock. This means that investors who undergo the conversion no longer have access to the fixed dividend that preferred stock offers. Additionally, shareholders no longer have preferred status in the event the company is forced to undergo liquidation of its assets at some point in the future.
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