Anti-Dilution Clause Definition
An anti-dilution clause is a contractual provision that protects investors from ownership dilution when a company issues new shares at a lower price than the investor's original purchase price. If a subsequent funding round occurs at a lower valuation (a "down round"), the anti-dilution clause adjusts the investor's share count to maintain their ownership percentage or economic value.
Why This Matters for Angel Investors
Angel investors face significant risk investing in early-stage companies. An anti-dilution clause provides downside protection by ensuring that future down rounds don't disproportionately harm their investment. Without this protection, an investor who owns 5% of a company could see their ownership percentage drop substantially if the company raises money at a lower valuation, even though they maintain the same number of shares.
Types of Anti-Dilution Protection
- Full Ratchet: Adjusts the investor's share price down to match the lowest price paid by any investor in a subsequent round. This is the most protective for investors but can be harsh on founders.
- Weighted Average: Blends the original price with the new lower price based on the amount of capital raised. This is considered more balanced and is more common in practice.
Example
Suppose you invest $100,000 for 10,000 shares at $10 per share, giving you 5% ownership. Six months later, the company raises a down round at $5 per share. With a full ratchet clause, your 10,000 shares might be adjusted to 20,000 shares to maintain your 5% stake. With a weighted average clause, the adjustment would be less dramatic.
Related Concepts
Understanding anti-dilution protection helps investors evaluate deal terms alongside other important provisions like liquidation preferences, board seats, and protective provisions. Investors should also consider how anti-dilution interacts with equity financing strategy.