Anti-dilution

Anti-dilution is a protective provision commonly included in investment agreements to safeguard the ownership interests of investors in the event of a future funding round at a lower valuation. It aims to prevent the dilution of an investor's equity stake by adjusting the number of shares they hold or the price at which they acquired those shares.

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There are different types of anti-dilution provisions, including full ratchet and weighted average adjustments. A full ratchet anti-dilution clause provides the most significant protection to investors by automatically adjusting the conversion price of their shares to the price per share in the subsequent financing round, regardless of the amount raised or the valuation. This means that if the new round has a lower valuation, the investor's conversion price is adjusted downward, effectively increasing their ownership percentage.

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On the other hand, a weighted average anti-dilution provision takes into account both the price and the number of shares issued in the subsequent financing round. It uses a formula that considers the new valuation, the old conversion price, and the number of shares issued to determine the adjusted conversion price. This method provides a more balanced approach that considers the overall impact of the new round on the investor's ownership stake.

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The inclusion of anti-dilution provisions in investment agreements serves to protect the interests of investors, particularly in situations where a company undergoes a down round or experiences a significant decrease in valuation. By adjusting the conversion price or the number of shares held by the investor, anti-dilution provisions help maintain their ownership percentage and mitigate the potential negative impact of a lower valuation on their investment.

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It's important for both investors and companies to understand the implications of anti-dilution provisions and carefully negotiate the terms to ensure fairness and alignment of interests. Anti-dilution provisions can have complex calculations and varying degrees of impact, so seeking legal advice is advisable to navigate the intricacies and nuances of these provisions effectively.