What is pay-to-play and why do some investors demand it?

Full Explanation

Pay-to-play provisions come in two forms. Hard pay-to-play strips anti-dilution and voting rights from investors who don't participate in the next round. Soft pay-to-play converts their preferred shares to common shares, reducing their preference but preserving voting rights. Investors favour pay-to-play because it prevents free-riding — investors who believe in the company commit capital; those who bail out lose protection. From the company's perspective, pay-to-play can be a hostile pressure mechanism: if an early investor can't or won't commit to the next round (due to fund restrictions, poor performance, or concentration limits), hard pay-to-play converts their preferred shares to common, effectively diluting their control. This is particularly aggressive in down rounds. Founder-friendly terms often exclude pay-to-play or use soft pay-to-play instead. The prevalence of pay-to-play increased post-2022 when capital became scarcer and investors wanted to separate committed from opportunistic LPs. Most Series A and later rounds now include pay-to-play.

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