Definition Anti-dilution provisions in a dilution. The purpose of these provisions is to protect investors’ stock ownership percentage in a company. adjust the number of common shares into which preferred shares convert in the event of a or other stock
When negotiating anti-dilution clauses, lawyers may not get into the details of how anti-dilution works. They should, however, advise you to request contingencies to anti-dilution clauses. These contingencies allow space—or “carve-outs”—for founders to get around the clause in certain standard circumstances, like issuing shares in an acquisition, offering options for employees, or taking on venture debt that allows you to do those things without triggering anti-dilution.
Anti-dilution can be calculated by a broad-based weighted average (or BBWA), or as full ratchet. BBWA is absolutely customary, whereas ratchet-based anti-dilution is very atypical. If you’re interested in reading more about either, we recommend reading Yokum’s “What is weighted average anti-dilution protection?” and “What is full ratchet anti-dilution protection?” at Startup Company Lawyer.
Definition Full ratchet anti-dilution is a form of anti-dilution that adjusts the rate at which convertible preferred stock can be exchanged for common stock to reflect the lower price of shares issued in a . This adjustment recalculates the number of shares of common stock into which each share of preferred stock is convertible by dividing the when the preferred stock was purchased by the price per share of common stock in the down round.* Full ratchet anti-dilution provisions benefit investors over founders because of the disparity they create between the values of common and preferred stock,* and they are relatively rare compared to provisions, which create less disparity.
If you raised an investment at $5 per share in one round, then raised a later round at $1 per share, each share of convertible preferred stock protected by full ratchet anti-dilution in the earlier round would be convertible into five shares of common stock. Those additional shares have to come from somewhere, which is what makes this approach controversial.
Definition Weighted average anti-dilution is a form of dilution to decrease the price at which preferred stock can convert into common stock. This form of anti-dilution takes into account not only the new but also the extent of the would-be dilution. As a result of its relative formula, weighted average anti-dilution produces a smaller adjustment than full ratchet anti-dilution* and is accordingly the more founder-friendly option.* that uses a relative (weighted) formula in a or other stock
The formula for weighted average anti-dilution compares:
the amount of money previously raised by the company and theat which it was raised, with
the amount of money currently being raised by the company in a dilution, and the at which this new money is raised.or other stock
The formula is typically expressed as CP2 = CP1 * (A+B) / (A+C) where:
danger If you are looking at a provision, pay close attention to the way the calculation is described. Different versions of this provision can especially vary in terms of how they calculate the number of shares before the or other stock dilution (variable A above).
important We strongly recommend consulting an attorney about any provisions you have been presented with or are considering. These calculations can get extremely complicated, and they can have serious downstream consequences.
That said, if you’re interested in learning more about how the calculations work, we recommend reviewing Cooley’s “What You Need to Know About Down Round Financings,” Frank Demmler’s “Weighted Average Anti-Dilution Protection,” and Yoichiro Takum’s “What is weighted average anti-dilution protection?.”