Antidilution

Antidilution refers to contractual protections, commonly included in preferred stock or convertible securities, that aim to shield investors from ownership dilution when a company later issues stock at a price per share lower than in earlier rounds. These provisions can adjust either the conversion price of the preferred stock or the number of shares issuable upon conversion to common stock.

There are two main types of antidilution protection. Full ratchet antidilution adjusts the conversion price of the existing preferred shares to match the lower price of a subsequent financing round, regardless of how many shares are issued. As a result, holders of the original preferred stock may receive a significantly larger number of common shares upon conversion, often increasing their ownership and reducing the ownership of others, such as founders and early investors.

Weighted-average antidilution provides a more moderate adjustment by blending the old and new prices based on the relative sizes of the rounds. The general idea is to issue a new, lower effective price that reflects both the original valuation and the amount of new money raised. Within weighted-average protections, broad-based and narrow-based variants determine which outstanding securities are counted in calculating the adjustment. Broad-based antidilution includes a wider set of dilutive securities (such as options and warrants) in the calculation, while narrow-based uses a narrower set.

Limitations and considerations: antidilution protections only apply to specified dilutive issuances and are not guaranteed to cover every form of value loss. They may not apply to stock splits, certain exempt issuances, or mergers and acquisitions governed by other terms. In practice, antidilution terms are a key negotiation point in venture capital and other private financings, balancing investor protection with the potential impact on founders and other shareholders.