An anti-dilution clause is a provision in a shareholder agreement designed to protect the interests of existing shareholders by preventing the dilution of their ownership percentage. It is a way of ensuring that the value of their investment is not reduced by the issuance of new shares.
The clause typically provides for adjustments to the number of shares owned by each shareholder in the event of a new issuance of shares at a lower price than the original price paid by the existing shareholders. The purpose of the adjustment is to ensure that the percentage ownership of each shareholder remains the same, despite the issuance of new shares.
For example, if an existing shareholder owns 10% of a company and the company issues new shares at a lower price than the original price paid by the existing shareholder, the anti-dilution clause would require an adjustment in the number of shares owned by the existing shareholder to maintain their 10% ownership stake.
There are several types of anti-dilution provisions that can be included in a shareholder agreement, including full ratchet, weighted-average, and broad-based weighted-average.
Full Ratchet: Under a full ratchet provision, the price at which the new shares are issued is adjusted to the original purchase price paid by the existing shareholder. This means that the existing shareholder`s ownership percentage is fully protected, but it can be quite expensive for the company to implement.
Weighted-Average: A weighted-average provision takes into account both the price and the number of shares outstanding, rather than just the price. This means that the new shares are issued at a price that reflects the overall value of the company, rather than just the original price paid by the existing shareholders.
Broad-Based Weighted-Average: A broad-based weighted-average provision is similar to a weighted-average provision, but it includes all outstanding shares, not just those held by existing shareholders. This type of provision is typically less expensive for the company to implement than a full ratchet provision.
In summary, an anti-dilution clause in a shareholder agreement is a way of protecting the interests of existing shareholders by preventing dilution of their ownership percentage. There are several types of anti-dilution provisions that can be included in a shareholder agreement, each with its own benefits and drawbacks. It is important to consult with a legal professional experienced in corporate law to determine which type of provision is best for your situation.