Anti-dilution provisions are contractual protections that prevent existing shareholders from having their ownership percentage reduced when new shares are issued at a lower price than they originally paid.
Anti-dilution provisions automatically adjust the conversion price of preferred shares when the company issues new shares at a lower valuation.
This means protected investors receive additional shares to maintain their proportional ownership.
The adjustment ensures they're not unfairly penalised by subsequent funding rounds at reduced valuations.
There are two main types: weighted average and full ratchet anti-dilution provisions.
Weighted average provisions (both broad-based and narrow-based) provide moderate protection by considering the size of the new issuance.
Full ratchet provisions offer maximum protection by adjusting the conversion price to match the lowest new share price.
Anti-dilution provisions usually trigger during down rounds, where new shares are issued at a lower price per share than previous funding rounds.
They also activate during certain stock option grants, warrant exercises, or other equity issuances below the protected price.
Most provisions include carve-outs for employee option pools and other routine issuances.
Investors use anti-dilution provisions to protect their investment value and ownership stake from unexpected dilution.
These provisions provide downside protection in volatile startup environments where valuations can fluctuate significantly.
They also help maintain the investor's influence and control rights within the company structure.
Anti-dilution provisions can significantly dilute founder ownership during down rounds, as the additional shares granted to protected investors come from the overall share pool.
Founders should understand that these provisions transfer dilution risk from investors to existing shareholders.
The impact varies greatly depending on the specific type of provision negotiated.
Founders should negotiate for weighted average rather than full ratchet provisions, as they provide more balanced protection.
Consider requesting carve-outs for employee incentive schemes and strategic partnerships.
Founders can also negotiate sunset clauses that eliminate anti-dilution rights after certain milestones or time periods are achieved.
