Pay-to-Play (Absent)

Why it matters

Pay-to-play is the clause founders should want and rarely get. With it, if a round is offered to existing investors and they don't participate at their pro-rata, they lose preferred-share status (their shares convert to common, or they lose anti-dilution protection). The effect: in a tough round, the lead must put in real money to keep the protections it negotiated, which keeps everyone aligned. Without it, existing investors can decline a follow-on, sit on their preference, and let new money rebuild the cap table around them — punishing the people who actually fund the next leg.

How to negotiate

Add it. Reasonable formulation: any existing investor who fails to participate at their pro-rata in a qualified financing has their preferred shares convert to common on a 1:1 basis, losing all preference, anti-dilution, and other special rights. Carve out small reserves for funds at end-of-life and follow-on prohibitions in their LPA. The clause sounds aggressive but is in fact the alignment mechanism most founders are missing — top-tier US firms generally accept it.

Example language

How this clause typically appears in a term sheet. Read it carefully — predatory language is often buried in routine paragraphs.

If any Major Investor fails to purchase its pro-rata share of any Qualified Financing, all shares of Preferred Stock held by such Investor shall automatically convert into Common Stock on a 1:1 basis and such Investor shall forfeit all preferential rights.