ANTI DILUTION

INVESTOR PROTECTION RIGHTS

Copyright @2016 HU Consultancy Pvt. Ltd. 1

Contents

Concept Pre Money / Post Money Valuation

Concept / Types of Anti Dilution

Anti Dilution Adjustment Mechanisms

Negotiating Anti Dilution provisions in VC/PE Term sheets

Concept Pre Money / Post Money
Pre Money Valuation = Valuation of the company prior to Investment
Post Money Valuation = What is the valuation of the company Post investment
Post Money Valuation = Pre Money Valuation + Investment Amount
Ownership % = Investment / Post Money
Price Per share = Pre Money Valuation / Pre Money shares

Example 1 : VC investor offers to invest $3MM into a startup for 30% of the company.
Post Money valuation = $3m / 0.30 = $10Mn

Example 2 : VC investor invests $4Mn investment at a $6Mn pre-money

Post Money = Pre Money + Investment
Post Money = $6Mn + $ 4Mn = $10Mn
Concept Anti Dilution Protection
Dilution refers to the phenomenon of a shareholders ownership percentage in a company
decreasing because of an increase in the number of outstanding shares
Value of the portion of the company owned by investor increases when company valuation
increases
Anti-dilution protection refers to protection from dilution when shares of stock of stock are sold
at a price per share less than the price paid by earlier investors
These Provisions get triggered in the context of a downround
Types Anti Dilution Mechanisms
Price Based Anti-dilution
Price-based anti-dilution adjustments involve increasing the number of shares of common
stock into which each share of preferred stock is convertible
Structural Anti dilution
This is an adjustment of the conversion price of their preferred stock into common stock upon
the occurrence of any subdivisions or combinations of common stock, stock dividends and
other distributions, reorganizations, reclassifications or similar events affecting the common
stock.
This type of anti-dilution protection ensures that the investor holding preferred stock is
treated as if such investor held common stock without the need to actually convert into
common stock and lose the features associated with the preferred stock held by such investor
Full Rachet Anti Dilution
Full ratchet works by simply reducing the conversion price of the existing preferred to the price at
which new shares are issued in a later round
Puts shareholders in the same position as if they had made their invest at the new lower price.
With this approach, the common stockholders bear all of the downside risk while both common
and preferred share in the upside
Full ratchet can also make later rounds more difficult
Dilutive effect on the ownership percentages of the founders and management can be severe and
destabilizing for the company.
Full Rachet Anti Dilution Example
Series A Preferred investors valued a company ABC Ltd at $50 million on a post-money. Series A
Investors Purchased four million shares at $5.00 per share, for a 40% interest in the company .
Remaining stake held by Promoters. Assume that New investor B has valued the company for $25M
pre money. Series B investor Invests $6.25Mn for 20% stake post Money

Since Series B investment is coming in at lower price per share compared to Series A due to drop in
Valuation, anti dilution provision gets triggered for Series A Investors
In Full Ratchet Series B price per share gets applied to Series A resulting in anti dilution shares
being issued to Series A investors to enhance their ownership stake.

Please refer the excel sheet for detailed working

Broad Based Anti dilution
Broad Based Weighted Average Anti Dilution
Weighted average The conversion price adjustment that early shareholders are entitled to
is a function of shares outstanding and shares issued in the down round
Formula results in reduced weighted average conversion price for Series A investors
resulting in higher conversion rate
Assumes conversion of all preferred stock, warrants, stock options and other convertible
securities
Most common kind of anti-dilution formula, and is usually not objected to by later
shareholders
Broad Based Anti dilution Formula
Broad Based Weighted Average Anti Dilution Formula:

NCP = CP x (CSO + AC/CP)/(CSO + AS),

where
NCP = New weighted average conversion Price of Series A investor
CSO = Common stock outstanding before the new round (including dilutive securities)
AC = New Investment Series B
CP = Old conversion price
AS = Number of shares to be issued in new round
Broad Based Anti dilution Example
Series C Pre financing capitalization Table of company ABC

Shares Type of securities

15,00,000 Common Stock
25,00,000 Series A Preferred Stock (issued at $1/share)
20,00,000 Series B Preferred Stock (issued at $2/share)
10,00,000 Options
70,00,000 Total

Also assume that there is a dilutive financing with the issuance of 2,000,000 shares of Series C
Preferred Stock at $0.50 per share, for total gross proceeds of $1,000,000.
Broad Based Anti dilution Example
Series A conversion Price adjustment :

= $1* ((70,00,000+(10,00,000/1) / (70,00,000+20,00,000))

= $1 *(8/9) = $0.88 = New weighted average conversion price

Thus, the number of shares of common issuable upon conversion of Series A is:
(2,500,000) x ($1.00 / $0.88) = 2,812,500

This results in a Series A Conversion Rate of 1.125:1

Series B conversion Price adjustment :

= $2 * (((70,00,000+(5,00,000/1) / (70,00,000+20,00,000))
= $2 * (7.5/9) = $1.67

Thus, the number of shares of common issuable upon conversion of Series B is:
(2,000,000) x ($2.00 / $1.67) = 2,400,000
This results in a Series B Conversion Rate of 1.20:1
Narrow Based Anti dilution
Narrow Based Weighted Average Anti Dilution
Only difference in Broad based and Narrow based is what constitutes CSO used in the
formula for arriving reduced conversion Price
The Formula does not take into account any dilutive securities
Formula results In reduced weighted average conversion price & higher conversion ratio for
Series A & B investors compared to Broad based Anti dilution (Prior example)
Comforting To Promoters compared to Full ratchet. However, higher magnitude of
conversion price adjustment compared to Broad based anti dilution
Narrow Based Anti dilution Formula
Narrow Based Weighted Average Anti Dilution Formula:

NCP = OCP x (CSO + AC/CP)/(CSO + AS),

where
NCP = New weighted average Conversion Price of Series A investor
OCP = Old conversion Price at Series A
CSO = Common stock outstanding before the new round (excluding dilutive securities)
AC = New Investment Series B
CP = Old conversion price
AS = Number of shares to be issued in new round
 Thank You
About the Author:
He is an MBA (Finance) with over 8 years of experience into
investment banking. Have undertaken extensive training in financial
modelling and has strong deal origination and execution experience on
Private Equity, M&A & Debt Syndication transactions across various
sectors.

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