Definition of Anti-Dilution Clause
An anti-dilution clause is a type of financial provision which provides investors with the right to maintain their ownership percentages if new shares are issued.
Let’s say that there are 10,000 shares available for Fictional Inc., and investor Joe Bloggs currently owns 20% (or 2,000) of them. If Fictional Inc. issues another 5,000 shares, an anti-dilution clause would mean that Joe Bloggs had the right to purchase another 1,000 shares to maintain his 20% stake. It would also protect him from losing money if the share price drops when the new shares are issued.
What is Dilution?
Dilution is what happens when a shareholder loses a percentage of their ownership in a business due to new shares being issued.
What Are the Types of Anti-Dilution Clause?
There are two main types of anti-dilution clause: full ratchet and weighted average.
Full Ratchet: These clauses protect investors who own options or securities, allowing them to convert at the lowest sale price that’s on offer. This helps to protect them if the new price is lower than the previous conversion price of the investor’s shares.
Weighted Average: These clauses use a formula to determine the new conversion price. The aim is to create an average price that factors in the number of shares that are owned and the prices at which they were purchased to find the fairest price possible.
What is the Weighted Average Formula for Anti-Dilution Clauses?
The weighted average formula for anti-dilution clauses uses the following data points:
- A: Shares outstanding before new issue
- B: Consideration received with new issue
- C: New shares issued
- O: Old conversion price
This is the formula that’s used:
New Conversion Price = O x (A + B) / (A + C)
How Do Anti-Dilution Clauses Offset Losses?
In some instances, when a company releases new shares, it can lead to a decline in the value of their existing shares. An anti-dilution clause will typically allow the investor to convert their shares to the new price.
This means that if an investor purchases shares for $100 per share and the company goes public with shares issued at $80, the investor would have the right to backdate their purchase price to $80 and to use the remaining funds to purchase more shares and maintain their ownership percentage.
What Are Some Other Names for Anti-Dilution Clauses?
Anti-dilution clauses are known under a variety of names, including subscription rights, subscription privileges and pre-emptive rights. They’re particularly common in venture capital, because there are often multiple rounds of financing.