Participation in future financing: Overview, definition, and example
What is participation in future financing?
Participation in future financing refers to the right of existing investors, lenders, or stakeholders in a business to take part in future rounds of financing or funding. This could involve the opportunity to purchase additional equity or debt securities when the company raises additional capital, often under the same terms as other investors or lenders. The participation right ensures that stakeholders can maintain their ownership stake or financial interest in the company as it grows and seeks additional funding. It provides an option for investors to continue supporting the business and avoid dilution of their existing interests.
For example, a venture capital firm that has invested in a startup may have the right to participate in the company’s next round of funding to maintain its percentage of ownership.
Why is participation in future financing important?
Participation in future financing is important because it allows existing investors or lenders to protect their financial interest in a company as it evolves and raises new capital. Without this right, stakeholders risk being diluted by new investors who may come in at later stages of funding. This right helps maintain the alignment of interests between the company and its current backers, ensuring that they can continue to benefit from the company's growth. It also demonstrates the company’s commitment to keeping key investors involved as it expands.
For businesses, offering participation in future financing can help attract initial investors by giving them the assurance that they can maintain or increase their stake as the business grows. For investors, this participation right ensures they can continue to capitalize on the business’s future success, while protecting their original investment.
Understanding participation in future financing through an example
Imagine a startup that has raised capital through an angel investment round. The agreement includes a clause that grants the investors the right to participate in future funding rounds. A year later, the company decides to raise additional capital through a Series A funding round. The angel investors are given the opportunity to purchase additional shares in the startup at the same terms as the new investors, allowing them to maintain their ownership percentage and avoid dilution.
In another example, a bank that has provided a loan to a company may include a participation clause in the loan agreement, allowing it to participate in a future equity offering. If the company decides to go public or raise additional capital, the bank can buy shares or convert part of the loan into equity, further securing its position in the company’s future growth.
An example of a participation in future financing clause
Here’s how a participation in future financing clause might appear in an investment agreement:
“The Investor shall have the right, but not the obligation, to participate in any future financing rounds of the Company, on the same terms and conditions as offered to other investors, to maintain its pro-rata ownership percentage in the Company. The Company shall provide the Investor with written notice of any future financing and the terms of such financing no less than [X] days prior to the closing.”
Conclusion
Participation in future financing is a key provision that protects the interests of investors, allowing them to maintain or increase their stake in a growing company. It is especially important in startup or early-stage investing, where businesses often go through multiple rounds of financing. This right ensures that investors are not diluted by new funding rounds and can continue to benefit from the company's success as it expands. For companies, offering this right helps attract initial investors and fosters long-term relationships with key stakeholders.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.