Venture capitalists move toward "pay to play"
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Venture capitalists are inserting a record number of "pay to play" provisions into term sheets, according to new data from law firm Cooley.
Why it matters: This is a sharp-elbowed reminder that VCs are facing performance pressure, and that startups are having a tougher time getting funded.
Jargon watch: "Pay to play" provisions also may be known as "cram down" clauses, and basically are designed to benefit new investors at the expense of existing shareholders who don't want to invest additional capital.
- The critical view is that this is unfair to insiders who took a chance when the company's prospects were more speculative, but who've either lost faith or no longer have money to spend (including early employees or VC funds without adequate reserves).
- The more charitable view is that such rounds are for companies that need money — not those that just want to bolster balance sheets — and that the new investors are vital to the company's future success. In short: Get on board or get out.
By the numbers: Cooley reports that 8.7% of all Q2 deals included such language.
- That's highest mark since Cooley began tracking in 2014, and the first time since Q1 2017 that it topped 8%.
Zoom in: "Pay to play" historically has been concentrated in later-stage deals, regularly topping double-digit percentage points (including last year), but that wasn't the case in Q2 2024.
- Instead, the largest percentage was in Series A rounds (13.7%).
- The main explanation is that most "pay to play" last quarter was for life sciences startups, where funding rounds often include milestone-based investments. In short, there's a discount included for investors who agree to particulate in the second tranche.
- A second explanation is that some later-stage companies have recapped, and thus raised "Series A" funding even though it may actually be a fourth or fifth funding round.
