Investors Bolt

It’s been an interesting few weeks in venture, with the talk of the town being Bolt’s $450M Series F round, which included some truly wild terms:

Most interesting to me isn’t the $200M of investment funds coming as “marketing credits,” the threat against one of the alleged lead investors, or bringing back the controversial CEO; it's the “pay-to-play” provision that purports to convert existing investors into common stock and redeem that stock at $0.01 per share if they don’t invest at 2x their pro rata (at a $14B valuation).

As reported by Eric Newcomer, Bolt’s initial email to preferred investors stated:

“Conversion and Pay-to-Play: In connection with the funding round, all outstanding shares of preferred stock of the company immediately prior to the closing of the funding round will be converted to common stock at a 1:1 ratio. If you participate in the funding round on at least a 2x pro-rata basis, your converted shares of preferred stock will be exchanged back into preferred stock (with the same relative liquidation preferences as the applicable former series of preferred stock). Based on your level of participation, you may also receive warrants to purchase common and preferred stock. If you do not participate in the round on at least a 2x pro-rata basis, your previously held shares of preferred stock will remain as common stock, and Bolt may repurchase up to 66.67% of the shares you hold for an aggregate price of $0.01 per share. Additionally, new holders of Series F Preferred Stock who are not holders of former series of preferred stock will be subject to a pay-to-play in the next financing round after this Series F round.”

Now, it appears that Bolt may be walking this back a bit, but the purpose of this post isn’t Bolt in particular—it’s exploring the mechanics of pay-to-play provisions, in general.

Pay-to-Play provisions essentially say that if the company raises funds from investors in the future, existing investors must invest their pro rata share, or their preferred stock will lose its preferential rights (e.g., liquidation preferences, anti-dilution protection), usually by converting into common stock or a shadow of preferred stock without such preferential rights.

Here is a pay-to-play provision proposed in the NVCA’s model Amended and Restated Certificate of Incorporation (revised for simplicity):

“In the event that any holder of shares of Preferred Stock does not participate in a Qualified Financing by purchasing in the aggregate, in such Qualified Financing and within the time period specified by the Corporation, such holder’s Pro Rata Amount, then each share of Preferred Stock held by such holder shall automatically . . . be converted into shares of Common Stock at the applicable Conversion Price in effect immediately prior to the consummation of such Qualified Financing, effective upon, subject to, and concurrently with, the consummation of the Qualified Financing. . . .”

As you can imagine, lawyers have devised various nuances, such as allowing the company to redeem some or a portion of the stock that did not “pay” to “play.” 

On paper, pay-to-play provisions seem to be “founder-friendly” because they add a twist to pro-rata rights.

For instance, investors often negotiate the right to continue participating in future rounds to maintain their level of ownership. Pay-to-play provisions go further by penalizing investors for not participating–i.e., allowing founders to incentivize investors to be long-term capital partners.

So, it’s founder-friendly in the sense that the founder can pull a string and pull back some of those preferential rights (like liquidation preferences) if investors don’t continue to participate. However, I wouldn’t consider these provisions “founder-friendly” because they still give investors pro rata rights (which could cause founders to suffer more dilution).

Moreover, these provisions aren’t usually proposed by a founder because they can be punitive to earlier investors–especially those who invested early in a company and may not be able to continue to invest the capital required to fulfill the pro rata–even if they wanted to. Most investors would push back even if a founder were to push for pay-to-play provisions.

Instead, pay-to-play provisions are usually proposed by a new investor proposing to invest in a company that is not doing particularly well, and the investor wants to de-risk the investment by conditioning its investment on participation by the existing investors. The new investors know that given the company’s current outlook, the company and its investors may not have many options. They can either take the deal, invest more money, and hope things turn around, or slowly watch their investment go to zero (at least according to the new investor).

Probably not, at least not without a vote. 

Pay-to-play provisions are located in a company’s charter. Because founders aren’t going to form their company with a pay-to-play provision built into its charter (at least not that I’ve seen), the charter needs to be amended, which would require stockholder approval. 

Moreover, preferred stockholders often have protective rights included in the charter, which would prohibit amending the charter without the approval of at least some percentage of the preferred stock (e.g., more than 50%). See the NVCA’s model Amended and Restated Certificate of Incorporation (revised for simplicity):

The Corporation shall not, either directly or indirectly by amendment, merger, consolidation, domestication, transfer, continuance, recapitalization, reclassification, waiver, statutory conversion, or otherwise, effect any of the following acts or transactions without the written consent or affirmative vote of the Requisite Holders (e.g., a certain % of the Preferred Stock) . . . amend, alter or repeal any provision of this Certificate of Incorporation or Bylaws of the Corporation . . . . 

So, in most cases, the preferred investors will have the right to approve (or at least vote) a transaction that will require them to impose a pay-to-play provision on their shares.

But that also ignores the practical realities I mentioned before–if the company needs money, and the only way a new investor will bring money to the table is by imposing a pay-to-play provision, then existing investors might not have any meaningful choice.

Also, we’ve assumed that the existing investors are preferred stockholders, which might not be the case. Theoretically, a pay-to-play provision could be imposed on the first priced round when the existing investors do not hold voting rights (e.g., they only hold SAFEs or Notes), but this seems highly unlikely given that pay-to-play provisions are used in later-stage down-round or flat financings and not initial priced rounds.

According to Carta, Q1 of 2024 marked a five-year high in the prevalence of down rounds (i.e., when the latest round is at a lower valuation than the previous round). Cooley reported that 8.7% of reported deals it saw included a pay-to-play provision in Q2 of 2024, representing the highest percentage since it began the reports in 2014.

This puts emerging fund managers and angel investors in a tough position because they are the least likely to have access to the capital necessary to fulfill the obligations imposed by pay-to-play provisions under the circumstances they ordinarily arise (e.g., later-stage down rounds).

These investors should consider including provisions in side letters granting them exemptions from any pay-to-play provisions in the future. In many cases, this would fit the practical purpose of pay-to-play provisions, incentivizing earlier investors with the practical means to continue to invest even when the company is not performing particularly well while not imposing harsh consequences on angels and smaller funds that have their unique role in the venture ecosystem but are not expected to participate in later stage financings. Startups might push back on this, particularly if those same investors ask for pro rata rights. A nice middle ground would be to tie the pro rata rights and exemption from pay-to-play provisions together (e.g., pro rata rights will only survive the first priced round).

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Hey, I am Shayn. I am the Founder of Junto Law and a partner at Capacity Capital. If you like this post, follow me on X or set a time to chat.

Disclaimer: While I am a lawyer who enjoys operating outside the traditional lawyer and law firm “box,” I am not your lawyer.  Nothing in this post should be construed as legal advice, nor does it create an attorney-client relationship.  The material published above is only intended for informational, educational, and entertainment purposes.  Please seek the advice of counsel, and do not apply any of the generalized material above to your facts or circumstances without speaking to an attorney.