What is an Anti-Dilution Provision?
How Does an Anti-Dilution Provision Work?
Anti-dilution provisions are sometimes called "subscription rights," "preemptive rights," or "subscription privileges." Anti-dilution provisions are particularly relevant for convertible preferred stock. Let's look at an example.
Assume you purchase Private Company XYZ preferred stock for $15 per share. The preferred stock is convertible, which means that you have the right to trade one share of preferred stock for one share of common stock.
Now let's assume Company XYZ decides to go public and issue common shares at $10 per share. This clearly devalues the incentive to convert your preferred share into common shares, because you'd be trading your $15 investment for a common share worth only $10. An anti-dilution provision could protect you against this if it states that if Company XYZ issues shares at a price lower than in previous financing rounds, the preferred shareholder gets more shares of common stock when he or she converts.
There are two kinds of anti-dilution provisions: the "weighted-average" provision and the "ratchet-based" provision. The ratchet provision offers existing shareholders the right to buy shares at the new lower price. The weighted-average provision gives shareholders the right to purchase shares at a price that accounts for the change in the old and new offering prices.