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ACADEMY: What is an anti-dilution provision?

Posted by Erica Duignan Minnihan on Jul 7, 2016 11:00:00 AM

 

Anti-dilution is another one of those somewhat complex concepts that involve plenty of algebra. Basically, the idea is that they are meant to protect investors in the case of a “down-round”, or a capital raise that happens at a valuation lower than the one in which you purchased your securities. Let’s say you made and investment in a company in 2015 when the market was relatively hot, and the founder convinced you to make a $1 million investment at a $9 million pre-money valuation in the Seed Round. But unfortunately in 2017, the market is not so frothy and the company is almost out of cash. In order to stay alive, they need to raise another $1 million at a $4 million pre-money valuation. If this happens without anti-dilution provisions, your stake would end up being diluted by 20% AND the value of your equity would be marked lower, meaning your $1 million investment would now be worth about $400,000, a 60% loss in value. However, if you had standard weighted average anti-dilution provisions in place, the value of your equity would be repriced at the weighted-average price of the 2 rounds, meaning you would “go back in cap table time” and pretend as though you had actually made the $1 million investment at a six and a half million dollar pre-money, In this case your equity would be worth about $615 thousand dollars, or 50% more. If you had “full ratchet” anti-dilution, you would actually reprice your whole investment at the price of the new round, which would increase the value of your equity to $1 million, keeping you whole, and increasing your ownership in the company to 20%. Most founders try not try agree to “full-ratchet” anti-dilution provisions, as it can be aggressively dilutive to founders, and a disincentive to follow on investors, as the full ratchet down applies regardless of the size of the down round. If the founders don’t have enough stake in the company, they are unlikely to give 150%.

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Topics: Venture Investing Academy