Adjustments for diluting issuances: Overview, definition, and example
What are adjustments for diluting issuances?
Adjustments for diluting issuances refer to the changes made to the value or quantity of outstanding shares or equity ownership in a company when new shares are issued, potentially diluting the value of existing shares. These adjustments are typically made to protect the interests of current shareholders in the event that the company issues additional shares, such as in a public offering, private placement, or stock options exercise. The goal is to maintain fairness and balance in the ownership structure and ensure that existing shareholders' ownership percentage and the value of their shares are not unfairly reduced due to the issuance of new shares.
Why are adjustments for diluting issuances important?
Adjustments for diluting issuances are important because they help preserve the economic value and voting power of existing shareholders when a company issues additional shares. Without these adjustments, existing shareholders might find their ownership percentage reduced (or "diluted"), which can negatively affect their influence in corporate decisions and their share of any profits (e.g., dividends). By including provisions for adjustments in the case of diluting issuances, companies protect the interests of their shareholders and ensure that any issuance of new shares is done fairly and transparently.
Understanding adjustments for diluting issuances through an example
For example, a company with 1 million shares outstanding sells an additional 200,000 shares in a new offering. Without any adjustments, the original shareholders would see their ownership percentage diluted because the total number of outstanding shares has increased. However, an adjustment clause could be included in shareholder agreements or stock options to ensure that the price or the number of shares held by current shareholders is adjusted to compensate for this dilution.
In another example, a company may issue new shares to employees under a stock option plan, but as part of the plan, it includes a mechanism to adjust the number of shares available to prevent existing shareholders from losing their proportional share of ownership. For instance, if an employee exercises their stock options, the total number of shares might be adjusted downward to ensure the overall equity dilution is kept within agreed limits.
An example of an adjustments for diluting issuances clause
Here’s how an adjustment clause for diluting issuances might appear in a shareholder agreement:
“In the event of any issuance of additional shares or securities that would dilute the ownership interest of existing shareholders, the Company shall make adjustments to the number of shares or the exercise price of outstanding options or warrants, in order to maintain the economic equivalence of the existing shareholder’s interest as if no issuance had occurred.”
Conclusion
Adjustments for diluting issuances are essential tools for protecting shareholders from losing value or influence when a company issues new shares. These adjustments ensure fairness and transparency, maintaining the integrity of the ownership structure and ensuring that all parties are treated equitably. By implementing appropriate adjustment clauses, companies can minimize the negative impact of equity dilution on existing shareholders and maintain a positive relationship with investors.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.