In an earlier post we discussed the use of anti-dilution provisions in NZ investment deals, and we invited SCIF to approve the use of US style weighted average anti-dilutes instead of the current, harsh, full ratchet anti-dilutes.

In this post we give some examples of the different outcomes that arise from the use of the two types of anti-dilution provisions.

The first table below shows an investor subscribing for a 50% shareholding in a company for $2,000,000 at a price per share of $1:

Party Existing Shares Existing Share % Investment Price Per Share New
Shares
Total
Shares
New
Share %
Founder 2,000,000 100% $0 N/A 0 2,000,000 50%
Investor 0 0% $2,000,000 $1 2,000,000 2,000,000 50%
Total 2,000,000 100% $2,000,000 2,000,000 4,000,000 100%

 

The next table shows what happens if the investor subsequently invests an additional $500,000 at $0.75 per share when a full ratchet anti-dilute applies:

Party Existing Shares Existing Share % Investment Price Per Share New Shares Full
Ratchet Shares
Total Shares Share %
Founder 2,000,000 50% $0 N/A 0 0 2,000,000 37.50%
Investor 2,000,000 50% $500,000 $0.75 666,667 666,667 3,333,334 62.50%
Total 4,000,000 100% $500,000 666,667 666,667 5,333,334 100%

 

In effect, the full ratchet retrospectively re-prices the original investment to $0.75 per share, resulting in a large uplift in the investor’s percentage shareholding.

The founder can improve their position somewhat by participating in the $0.75 per share round. However, the number of shares issued in accordance with the full ratchet anti-dilution provision is unchanged, and as a consequence the founder’s percentage shareholding is still reduced by a material amount even though the participants participated equally in the round. The table below reflects the same $500,000 investment split equally between the founder and the investor:

Party Existing Shares Existing Share % Investment Price Per Share New Shares Full
Ratchet Shares
Total Shares Share %
Founder 2,000,000 50% $250,000 $0.75 333,333 0 2,333,333 43.75%
Investor 2,000,000 50% $250,000 $0.75 333,333 666,667 3,000,000 56.25%
Total 4,000,000 100% $500,000 666,666 666,667 5,333,333 100%

 

Under a weighted average anti-dilution calculation, the investor is issued additional shares (independent of any participation by the investor in the subsequent round) so that the investor’s original investment is only diluted to the same extent that it would have been diluted if the new shares had been issued at the original investment price ($1 per share in this case), but is insulated from any additional dilutionary effect as a result of the new shares being issued at the lower price per share.

The table below reflects the same $0.75 per share round as before but applies a weighted average anti-dilute:

Party Existing Shares Existing Share % Investment Price Per Share New Shares Weighted Average Shares Total Shares Share %
Founder 2,000,000 50% $0 $0.75 0 0 2,000,000 42.19%
Investor 2,000,000 50% $500,000 $0.75 666,667 74,074 2,740,741 57.81%
Total 4,000,000 100% $500,000 666,667 74,074 4,740,740 100%

 

With the founder participating equally in the $0.75 per share round:

Party Existing Shares Existing Share % Investment Price Per Share New Shares Weighted Average Shares Total Shares Share %
Founder 2,000,000 50% $250,000 $0.75 333,333 0 2,333,333 49.22%
Investor 2,000,000 50% $250,000 $0.75 333,333 74,074 2,407,407 50.78%
Total 4,000,000 100% $500,000 666,666 74,074 4,740,740 100%

 

For those who like the detail, here are the formulae for these two approaches to anti-dilution protection:

Full Ratchet Basis:

Total number of investor shares = A/B where:

A = the dollar amount invested by the investor

B = the lowest price per share in the subsequent round

Weighted Average Basis:

Total number of investor shares = A/B, where:

A = the dollar amount invested by the investor

B = the original price per share paid by the investor x C

C = D/E

D = total existing shares + (new money from subsequent round/original investor share price)

E = total existing shares + number of new shares issued as part of the subsequent round.

 

 

by , 7 March 2014