What does anti-dilution protection mean in a term-sheet?


3

My question is in the context of a Term-sheet. I want to know what does anti-dilution preferences mean?

Definitions Legal Investment Term Sheet

asked Oct 18 '12 at 05:36
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Lisa Howard
116 points

2 Answers


5

Anti Dilution basically protects an investor against a situation where a future round will be raised in lower price per share (lower valuation) compared to the price he received.

Basically you are guaranteeing the investor a price match if any future investor will get a better price than he did.

Technically, this is done by increasing the conversion rate of the preferred and accordingly increasing the number of shares of common stock into which a share of preferred stock converts.

There are two kinds of anti-dilution:

  • weighted average
  • ratchet anti-dilution.

Weighted Average is basically milder so it's not a full price match but somewhere in between the original price and the better price the other investor received. Ratchet is the full price match.

You didn't really ask for advice but this is a term you should probably avoid. Even if you are absolutely sure there will never be a down round compared to the current round, any future investor will want to put that in as well once you agreed to do that with one investor so the bar will get higher and higher.

answered Oct 18 '12 at 05:39
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Scott Fisher
151 points

4

"Anti-dilution protection" itself doesn't mean something exact and standardized. To know it more exactly, you will have to read the full clause, and consult with a lawyer who has expertise in startup financing.

"Anti-dilution" is often used in one of three meanings:

  1. Most common: To protect investors in case a future financing round is raised at a lower per-share price, a.k.a a down round. See @Scott Fisher 's excellent answer.
  2. Less common: To protect preferred stocks in the case of a stock split or other similar re-classification of stocks (i.e to ensure that preferred stock is treated the same as common stock in these cases). See "The Venture Capital Anti-Dilution"
  3. Said by rank amateurs: A provision which says that one or a few investors will keep their ownership percentage intact if additional rounds of investing are required, at the expense of greatly diluting someone else. I.e. if Investor A gets 10% of the company in an Angel round, then he maintains 10% total ownership even if later rounds of investment are needed. To the best of my knowledge, this is a red herring which comes from the movie "The Social Network". No competent investor would ever accept others having (or even asking for) this.
answered Oct 18 '12 at 05:59
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Jesper Mortensen
15,292 points

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Definitions Legal Investment Term Sheet