Pay-to-Play Becoming Less Common in Venture Capital

To motivate investors to reinvest in additional rounds of financing at start-up companies, venture capital deals often include “pay-to-play” provisions. Under these provisions, investors that don’t reinvest have their preferred stock converted to common stock or otherwise made less preferential, VC Experts explains.

According to venture capitalist Brad Feld, pay-to-play provisions were rare in the 1990s. But after the Internet bubble popped in 2001, they became very common. New data show that investors have moved away from pay-to-play provisions in recent years.

The figure below shows data on the share of venture capital deals with pay-to-play provisions taken from the Venture Capital Report produced by law firm Cooley LLP. While the data only cover deals for which Cooley did the legal work, they show the frequency with which VCs are using pay-to-play provisions.

While the trend is imprecise, the pattern is clear. Pay-to-play provisions have become less common since the fourth quarter of 2003 when Cooley first began to track this measure.

What does this trend mean for venture capital? Pay-to-play provisions encourage investors to reinvest when the condition of a business isn’t encouraging. If fewer venture capital deals have pay-to-play provisions then VCs will be less likely to put additional money into start-ups in down rounds than they used to be.

Source: Created from data from the Cooley Venture Capital Report, various issues


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

2 Reactions
  1. With the decrease in IPOs and other exits, it makes sense that VCs wouldn’t want to limit their ability to take a payday and run.

  2. We expect to see the use of pay to play provisions increase in 2012 and 2013.

    The last two years has seen a surge in seeded startups (mostly by Angels and Super Angels). Many of these firms are going to need A/B rounds and we think it’s going to be a struggle for a lot of these firms to get funded.

    This will lead to investors triaging their portfolios and adding pay to play provisions to get their good companies funded.