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An anti-dilution provision is a protective clause commonly found in venture capital and private equity agreements. It is designed to shield early investors from a reduction in their ownership percentage when a company issues new shares at a lower valuation.
Anti-dilution provisions are contractual clauses that adjust the price or number of shares held by existing investors when new shares are issued at a price lower than what they originally paid. This mechanism ensures that their investment value is not disproportionately eroded in subsequent funding rounds.
These provisions are used to:
Protect early-stage investors from the negative impact of future down rounds.
Maintain the economic value and equity stake of investors.
Provide confidence and assurance to investors about maintaining fair ownership despite valuation changes.
Anti-dilution provisions come in several forms, each offering varying levels of protection to existing investors when new shares are issued at lower valuations.
| Type | Description |
|---|---|
Full Ratchet |
Adjusts the price of earlier shares to match the new lower issue price, regardless of the number of new shares issued. |
Weighted Average |
Adjusts share price based on the weighted average of old and new share prices. |
Broad-Based Weighted Avg |
Consider all shares (common and preferred) when calculating adjustment. |
Narrow-Based Weighted Avg |
Only includes preferred shares in the calculation. |
Contractual |
Tailored clauses negotiated case-by-case, possibly combining elements above. |
Example: A venture capital investor buys shares at ₹500 each in a startup. A year later, the company raises a new funding round, but the fresh shares are issued at ₹200 each.
Full Ratchet: The original investor’s conversion price is reset to ₹200, giving them the same benefit as if they had originally invested at the new lower valuation.
Anti-dilution provisions significantly influence the equity dynamics between founders and investors, especially during subsequent funding rounds—most notably, down rounds (where shares are issued at a lower valuation than previous rounds).
Ownership Dilution for Founders:
In the event of a down round, anti-dilution adjustments can reduce the founders' ownership percentage, as more shares are allocated to existing investors to protect their economic stake. This can affect the founders’ long-term control and decision-making power in the company.
Investor Protection and Influence:
These provisions are designed to preserve the value of an investor’s stake. By receiving additional shares or having their conversion price adjusted, investors retain a larger economic interest than they otherwise would, ensuring their initial valuation is honored to a degree.
Negotiation Complexity:
Including anti-dilution clauses can complicate the negotiation of term sheets and shareholder agreements. Founders may need to trade off between securing funding and preserving equity or control.
Impact on Future Rounds:
A heavily adjusted cap table resulting from aggressive anti-dilution terms can deter new investors, especially if prior investors hold disproportionate influence or equity.
Perceived Valuation Signal:
The invocation of anti-dilution provisions may also signal poor performance or overvaluation in earlier rounds, potentially affecting the company's credibility and market perception.
Anti-dilution provisions serve to protect investor equity when subsequent funding rounds occur at lower valuations. They vary in structure and effect but are standard tools in venture and private equity to balance risk between founders and investors.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
An anti-dilution provision is a clause that protects early investors from losing ownership value when new shares are issued at lower prices than their original investment.
Full ratchet resets the original investor’s share price to the new lower price.
The weighted average makes a proportionate adjustment based on the volume and price of new shares.
These clauses are typically found in venture capital, private equity, and convertible debt or preferred share agreements.
No. They usually apply only to preferred or institutional investors, not common shareholders unless specified.
They can dilute founders’ ownership in down rounds and create negotiation complexities in later-stage funding. This may impact future control and strategic decisions.
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