Types of Anti Dilution Clauses
Full Ratchet Anti Dilution
This is the most aggressive form of anti dilution protection. It adjusts the price per share of the original investment to match the price per share of the new issuance. While it offers maximum protection for investors, it can be highly dilutive for
founders and other shareholders.
Weighted Average Anti Dilution
This method is more balanced and calculates a weighted average of the old and new share prices. It offers some protection to investors while not overly penalizing existing shareholders. There are two main types:
Broad-based: Includes all shares on a fully diluted basis, offering a fairer adjustment.
Narrow-based: Only considers shares outstanding, which can be more favorable to investors.
How Do Anti Dilution Clauses Affect Entrepreneurs?
While anti dilution clauses protect investors, they can also impact
entrepreneurs significantly. Founders may see their ownership percentage reduced, which could affect their control over the company. It's essential for founders to carefully negotiate these terms to balance investor protection with the company's long-term health.
Key Considerations for Entrepreneurs
When negotiating anti dilution clauses, entrepreneurs should consider: Type of Protection: Understand the difference between full ratchet and weighted average and negotiate terms that balance investor protection with founder equity.
Future Fundraising: Consider how future funding rounds may trigger anti dilution provisions and plan accordingly.
Investor Relations: Maintain open communication with investors to manage expectations and avoid potential conflicts.
Common Scenarios Triggering Anti Dilution Clauses
Common scenarios include: Down Rounds: When the company raises capital at a lower valuation than previous rounds.
Issuance of New Shares: When new shares are issued, potentially diluting existing investors.
Convertible Securities: Conversion of convertible notes or preferred shares into common stock.
Conclusion
Anti dilution clauses play a critical role in protecting investors and shaping the relationship between
entrepreneurs and investors. While they offer necessary protection for early-stage investors, they can also impact founders and existing shareholders. By understanding the various types of anti dilution provisions and negotiating carefully, entrepreneurs can ensure a balanced approach that supports the company’s long-term success.