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Anti-Dilution Provision

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What is an Anti-Dilution Provision? 

An anti-dilution provision is a clause in an investment agreement that protects an investor from dilution of their ownership percentage in the event that new shares are issued at a price lower than the investor originally paid. It is commonly included in venture capital and private equity agreements.

How It Works:

  • Types: Two main types are full ratchet and weighted average.some text
    • Full Ratchet: Adjusts the conversion price of the existing shares to the new lower price.
    • Weighted Average: Adjusts the conversion price based on the average price of new shares issued.
  • Trigger: Activated when the company issues new shares at a lower price than the initial investment price.

Advantages: 

Anti-dilution provisions protect early investors by maintaining their ownership percentage and investment value. They ensure that early investors are not unfairly diluted by future funding rounds at lower valuations.

Disadvantages: 

These provisions can be unfavorable for founders and other shareholders, as they may lead to significant dilution of their ownership. They can also complicate future financing rounds and negotiations with new investors.

Impact on Future Funding: 

Anti-dilution provisions can influence the company's ability to attract new investors, as the adjustments may lead to complex cap tables and reduced incentives for new investments. It is crucial for companies to balance protecting early investors with maintaining flexibility for future financing rounds.

Example: 

In 2008, during the financial crisis, Facebook issued new shares at a lower price to attract investors. Early investors with anti-dilution provisions had their ownership percentages adjusted to reflect the new lower share price, thereby protecting their initial investment value.

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Related Terms

Adjusted EBITDA

Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a financial metric used to assess a company's operational performance. It modifies the standard EBITDA by excluding non-recurring, irregular, or non-cash expenses to provide a more accurate reflection of ongoing profitability.

Angel Investors

Angel investors are affluent individuals who provide capital to startups or early-stage companies in exchange for equity ownership or convertible debt. These investors often offer not only financial support but also valuable business expertise and mentorship.

Bootstrapping

Bootstrapping in business refers to starting and growing a company using personal finances or the company’s operating revenues, rather than relying on external funding or venture capital. Entrepreneurs use their own resources and reinvest profits from initial sales to fund further growth, emphasizing financial independence and careful cash flow management.

Bridge Loan

A bridge loan is a short-term loan used to meet immediate financing needs while waiting for more permanent funding. It serves as a temporary solution to bridge the gap between the need for funds and the availability of long-term financing.

Cap Table

A Cap Table, or Capitalization Table, is a detailed spreadsheet or document that outlines the equity ownership, types of shares, and ownership percentages of a company. It includes information on founders, investors, and employees, as well as the dilution of shares over time through various funding rounds and option grants.

Clawback Provision

A clawback provision is a contractual clause that allows an employer or investor to reclaim previously distributed compensation or bonuses from an employee or executive. This provision is typically included in employment contracts, bonus agreements, and investment terms to protect against misconduct, underperformance, or financial restatements.

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