Antidilution rights: Overview, definition, and example
What are antidilution rights?
Antidilution rights are provisions in a contract, often found in investment agreements or shareholder agreements, that protect investors from the dilution of their ownership percentage in a company. Dilution occurs when a company issues more shares, which can decrease the value of existing shares and reduce an investor's percentage of ownership.
Antidilution rights are typically granted to early investors, venture capitalists, or shareholders to ensure that their stake in the company remains proportionally unchanged, even if the company raises more capital by issuing additional shares. There are two main types of antidilution rights: weighted average antidilution and full ratchet antidilution.
- Weighted average antidilution: Adjusts the price at which the investor’s shares are valued based on the average price of the new shares issued.
- Full ratchet antidilution: Adjusts the price of the investor’s shares to match the price at which the new shares are issued, regardless of the number of new shares issued.
Why are antidilution rights important?
Antidilution rights are important because they help protect investors from losing the value of their investments when a company raises additional capital. For investors, especially those who have invested early in a business, these rights provide assurance that their ownership stake won’t be unfairly diluted by future funding rounds or other share issuances.
For companies, offering antidilution rights can be a useful tool to attract and retain investors. It shows that the company values its investors and is committed to protecting their interests. However, it’s also a balancing act, as these rights can affect the company’s flexibility in raising capital or issuing new shares in the future.
Understanding antidilution rights through an example
Imagine you’re an early investor in a startup and own 20% of the company. The company later raises a new round of funding by issuing additional shares, which reduces your ownership percentage. Without antidilution rights, your 20% stake might shrink significantly. However, with antidilution rights, you are protected from this dilution, meaning the company might adjust your ownership percentage or the price of your shares to preserve your original stake.
For example, if the company raises funds by issuing new shares at a lower price than what you originally paid, the antidilution clause may adjust the price of your shares downward, effectively protecting you from the loss of value due to the lower-priced shares.
Example of an antidilution rights clause
Here’s an example of what an antidilution rights clause might look like in an investment agreement:
“In the event the Company issues additional shares at a price lower than the price per share paid by the Investor in the previous funding round, the Investor’s shares shall be adjusted on a weighted average basis, reducing the price per share paid by the Investor in proportion to the number of newly issued shares and their price.”
This clause outlines the protection for the investor if the company issues new shares at a lower price, ensuring that the investor’s ownership is not unfairly diluted.
Conclusion
Antidilution rights are essential for protecting investors from losing value in their shares when a company issues additional shares. These rights provide confidence to investors, particularly early ones, that their stake in the business won’t be diluted unfairly in future funding rounds. For businesses, offering antidilution rights can be an important tool for attracting investors but must be carefully considered to balance future capital-raising flexibility. Understanding and negotiating these rights can help ensure fair treatment of investors and stability for the company as it grows.
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.