As startups seek funding to accelerate growth and expand their business, they turn to equity financing, which involves selling shares of the company in exchange for capital. In these transactions, investors may require anti-dilution protection to ensure that their investment’s value is not diluted by future equity sales.
Anti-dilution clauses come in different forms, but the two most common types are full ratchet and weighted average. Full ratchet anti-dilution guarantees that the investor maintains their percentage of ownership in the company by adjusting the conversion price of their shares to the current round’s price. In contrast, weighted average anti-dilution adjusts the conversion price based on a formula that considers the current round’s price and the number of shares outstanding.
While anti-dilution clauses may seem like a win-win for both startup founders and investors, they can have different implications for both parties. For example, full ratchet anti-dilution is more favorable for investors, as it significantly reduces the conversion price, which can lead to a significant increase in their ownership percentage. On the other hand, weighted average anti-dilution is less favorable for investors but less punitive for the company since it spreads the adjustment across all shareholders.
Therefore, startup founders and investors must understand the potential impact of anti-dilution clauses and negotiate them accordingly. Often, investors will demand anti-dilution protection in exchange for their investment, so founders must be prepared to navigate these negotiations.
In conclusion, anti-dilution clauses are a common feature of startup funding rounds that can protect investors from the dilution of their ownership percentage. However, founders and investors must understand the different types of anti-dilution clauses and their implications to ensure that they are negotiating the best deal for both parties.
