Attracting Capital – How To Design Anti-Dilution Provisions For Investors
Offering anti-dilution provisions for investors reassures them of their ownership stake in the company regardless of future funding rounds. Such provisions make the investment attractive, raising the success ratio of your fundraising initiatives.
Offering anti-dilution provisions for investors reassures them of their ownership stake in the company regardless of future funding rounds. Such provisions make the investment attractive, raising the success ratio of your fundraising initiatives.
Understand that investors offering capital are primarily concerned about how their equity stake will be affected. Particularly when you issue new shares to raise capital for the growing company. Including anti-dilution safeguards protects investors’ and common shareholders’ interests.
Typically, these provisions form a part of venture capital funding agreements. Investors may include certain clauses that trigger anti-dilution protection. These clauses are any company activities that can diminish their percentage claim on the company’s assets.
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What are Anti-Dilution Provisions?
When a company issues new shares at prices lower than those paid by investors in earlier rounds, that can cause an equity dilution. To prevent this from happening, VCs include clauses that protect them from the possibility of their investment losing value.
Anti-dilution provisions in the investor agreement or company charter are also called pre-emptive rights, subscription privileges, or subscription rights. Let’s try an example. An investor has a 20% stake in a company, and you must initiate a fresh funding round.
In that case, before offering new shares to the open market, you’ll offer them to existing investors at discounted prices. That’s how you can pre-emptively mitigate the dilution of their ownership stake in the company. Anti-dilution clauses are also included in convertible and preferred shares.
Investors owning preferred stock or convertible notes and bonds can use anti-dilution provisions to adjust the conversion prices. They can exercise this right when the company issues new shares at lower prices. Accordingly, the investor can increase the number of shares they can claim.
As a result, they can preserve their ownership stake in the company and their investment value. Such clauses can be of two kinds. For instance, full ratchet anti-dilution and weighted average anti-dilution, according to the level of protection they offer.
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