Pay-to-Play

Abstract

Pay-to-play clauses are a surprisingly understudied feature of venture capital financing deals. These provisions are designed to act as enforcement agents, securing investors' long-term commitment by penalizing those who decline to provide additional funding when their portfolio startups come calling. Through an analysis of a novel dataset of pay-to-play clauses, this paper uncovers surprising patterns in how US startups design and deploy them - most notably, their tendency to discriminate among investors despite legal guidance suggesting otherwise. The paper illustrates how pay-to-play clauses can increase enterprise value by addressing flaws in startups' governance and capital structures, preventing destructive "chicken" games among investor syndicates and fine-tuning investors' use of staged financing to minimize agency costs. The paper also offers a discussion of Delaware's treatment of these clauses, observing how lingering enforceability concerns might hamstring efficient clause design and nudge drafters to use low-visibility contractual alternatives rather than transparent, charter-based pay-to-play arrangements.