Anti-Dilution

Anti-Dilution is the increase in earnings per share or decrease in loss per share that results when once assumes the conversion of convertible instruments, the exercise of options and warrants, or issuance of ordinary shares if specified conditions are satisfied.

Anti-Dilution rights are a form of price protection, plain and simple. Unfortunately, there is nothing plain and simple about the issues which this simple concept throws up in practice. In essence, anti-dilution rights ensure that the price at which a shareholder purchased shares in a company is adjusted to take account of specified future share subscriptions at a lower price, so that the shareholder is never embarrassed by subsequent lower priced share issues. Anti-dilution protection is a slightly strange item which carries little intellectual legitimacy, however which is extraordinary prevalent in venture capital financing terms.

Full ratchet anti-dilution

There are two bases conventionally used to determine the nature of the anti-dilution protection: the so called “full ratchet” and the “weighted average” approaches. The full ratchet mechanism is extremely simple- this approach simply asks two questions:

•  What is the price per share at which the down round too place?
• What is the number of additional shares which would have to be issued to those shareholders with anti-dilution protection in order to ensure that the entirely of their shares (or at least those classes which have anti-dilution protection) are, on average, issued at that price per share?

Where a large down round triggers anti-dilution protection, this seems an obvious and straightforward approach- and it is. However, where it starts to fall is in relation to more modest share issues, where the full ratchet mechanism makes no adjustments for relative dilution. At the far end of the spectrum, this could operate arbitrarily and totally without regard to the reality of the situation

Questionnaire:

• What is Anti-Dilution?
• What are Anti-Dilution rights and protections?