30.5.2: Archived- Note on 'Pay-or-Play'

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Abstract

One of the most troublesome issues in the antidilution area is the "free rider" problem. If the preferred holders own stock convertible at $1 and Newco gets in trouble, the preferred holders may (assuming there is hope) agree to put up more money. If the new price is 500, the common stockholders will be diluted accordingly, a result they may find equitable in the case of those Investors who are participating in the dilutive round. However, they are likely to view it as highly inequitable-as indeed, will the Investors investing fresh cash-if a preferred holder who refuses to pay "his share" of the current round (a financing in the nature of an assessment) also gets more stock because of the automatic operation of the antidilution provisions. Hence, if Newco is privately held, financial engineers have structured an animal named a "play or pay provision", a provision in a given...