Pari Passu is a law term, made with two latin words pari meaning “an equal” and passu meanings “step” which are translated as “in equal proportion” or “on equal footing”. It is used to describe any instance where object is divided in equal proportion among related parties.
In bankruptcy, the term is used for creditors in which they are told that equal proportion of assets will be distributed without considering preference between them.
In venture capital, the pari passu is used to indicate that one equity holder will have the same rights as another equity holder.
In most companies, the term is also used for common stocks, meaning that no common stock holder will get privilege while dividend distribution.
Suppose company A requires capital of $5 million to invest in a new project. For this, it contacted with three venture capital firms which will invest capital as under:
Firm A = $3 million
Firm B = $1 million
Firm C = $1 million
During final negotiation phase, the management of the company A is provided with term sheets to sign which state that equity provided by Firm A will be parri passu to all other series of equity. The purpose to use the term here is that Firm A will have the same rights and privileges as other Firm B and Firm C.
Why it matters (Importance)
The term is used to ensure that borrower does not has right to create a class of senior or preferred parties while distributing resources in the event of insolvency. New lenders prefer to introduce parri passu clause while granting the loan in order to minimize risks and secure their investments.