We have come across Plug and Play investment deals. As we review the investment agreements from them, it is crucial to bring your attention to several clauses that pose significant risks to your equity, control, and future fundraising flexibility. These terms, if left unaddressed, could severely impact your ability to grow and maintain control of the company. Below, we outline the most concerning provisions and our strong recommendations for immediate action:
1. Guaranteed 200% Return in Liquidity Events
Clause Summary:
Plug and Play’s agreement guarantees them a minimum return of 200% of their investment (the "Cash-Out Amount") during a liquidity event, such as an acquisition, IPO, or merger. Alternatively, they may choose to receive an equity conversion based on the "Liquidity Price" if it provides a higher return.
Risks:
- Priority Over Founders and Stakeholders: This provision ensures that Plug and Play recoups their investment with a 2x multiplier before any other stakeholders, including founders and employees, see proceeds.
- Potential to Absorb Proceeds: In a modest or moderately valued exit, this clause could claim a substantial portion of the proceeds, leaving minimal returns for others.
- Precedent for Future Investors: Allowing this clause could encourage future investors to demand similar 2x preferences, creating long-term challenges in negotiating fairer terms.
Recommendation:
This clause is extremely aggressive and unfair. We strongly recommend working with your lawyer to negotiate its removal or, at the very least, significantly cap the guaranteed return to something more equitable.
2. Overreaching Anti-Dilution Protections
Clause Summary:
The agreement grants Plug and Play the right to purchase additional shares to maintain their ownership percentage in scenarios where:
- Equity is issued to founders (e.g., compensation, restructuring, etc.), or
- Founders receive equity from a third party.
This clause could set a precedent for investors to demand disproportionate control over equity decisions, potentially affecting founder autonomy and limiting flexibility in managing equity grants or transactions.
Risks:
- Founder Dilution: Standard compensation practices for founders could unintentionally trigger this clause, diluting your ownership.
- Overly Broad Scope: Even third-party transactions involving founders—which should have no bearing on Plug and Play’s stake—could activate this right, giving them an unfair advantage.
- Loss of Flexibility: The clause limits your ability to make decisions about founder equity without triggering these protections for the investor.
Recommendation:
This clause is unreasonable and overly broad. Insist on removing or significantly narrowing the scope of this provision to exclude routine founder equity grants and unrelated third-party transactions.
3. $500,000 Right of First Offer (Participation Rights)
Clause Summary:
Plug and Play’s agreement grants them the right of first offer to purchase up to $500,000 in new securities, which could make the company less attractive to future strategic investors by limiting their opportunities to participate in financing rounds. during equity financing rounds. This amount can be apportioned among the investor and their affiliates.
Risks:
- Reduced Fundraising Flexibility: Plug and Play’s right to claim a significant portion of future financing could limit opportunities for new strategic investors.
- Crowding Out Other Investors: In smaller financing rounds, the $500,000 cap could represent a large share, potentially deterring other participants.
Recommendation:
This clause undermines your flexibility in future fundraising. Work with your lawyer to limit their participation rights to their pro-rata share or restrict this right to larger financing rounds.
Strong Recommendation:
These clauses are highly aggressive and skewed in favor of the investor. If left unchanged, they could severely impact your equity position, decision-making flexibility, and ability to secure future investment. Furthermore, leaving these clauses unchallenged might create long-term challenges in negotiating fair terms with other investors, as they could become a baseline for future deals.
- Engage your lawyer immediately to conduct a detailed review of these clauses and negotiate their removal or significant revision. These clauses are atypical and could create long-term issues; therefore, it is crucial to involve legal counsel experienced in venture financing.
- Push back firmly on terms that prioritize investor interests at the expense of founders and the company’s long-term success.
- Consider alternative investors if Plug and Play refuses to negotiate fairly. These terms are not standard and should not be accepted as-is.
By addressing these concerns now, you can safeguard your ownership, maintain flexibility in future funding, and ensure a more equitable relationship with investors.
If you have further questions or need support in negotiations, please reach out immediately.
