VC financing terms: antidilution

This is an opinion piece by Rickard Vernet, investor and legal expert with a long background helping startups. He has a background at Vinge (law firm), Pale blue dot (VC fund) and is now at Bolago (formerly known as StartupTools) where he works with creating legal tools for startups and growth companies. Rickard is also co-founder of NaturaTua, a startup enabling private investments in biodiversity.

With the end of the ZIRP era, it is now more than ever critical for founders to understand the implications of the financing terms they agree to – especially the opaque and complex ones.

The most opaque clause of them all? The antidilution clause.

It’s the lovely mix of law and math. It’s the part where your lawyer might just say “it’s complicated”. Or where your investor will mutter something about “the term sheet template”.

💡 What is antidilution protection?

A mechanism for compensating investors in case of a future down round, where shares are issued at a lower price than what the investor paid in the earlier round. Shares held by the investor are “re-priced” based on the terms of the downround.

Re-pricing can be based on a ratchet or a weighted average calculation, and can be done by either an additional issue of shares for free (common in Europe), or by adjusting the conversion rate between preferred and common shares (common in the US).

Anti-dilution rights are a standard feature in VC financing. There are arguments both for and against the inclusion of antidilution clauses (but let’s stick to the mechanics here). The clause can be combined with a limitation in time, pay-to-play requirements and/or waiver rights for the investor majority holding AD rights.

It should be assumed that the down round investors will not agree to be diluted by the AD clause, so share price calculation in the down round will include the antidilution shares.

Examples

Here are some examples of mechanics (for the antidilution clause calculations – see the link for some simple examples that you can play around with)

Assumptions:

100k founder shares + 10% ESOP (post-seed) = approx 114 750 shares.
Seed round of 2M raised at 7M pre-money = 32 786 new shares.
Downround of 1.1M raised at 4.5M pre-money
ESOP dilution = 12,85%
Seed round dilution = 22,22% (2M/9M post money)
Founder ownership post seed = 67,78%

Downround w/o antidilution protection
- round dilution = 19,64% (1,1M/5,6M post money)
- Founder ownership post downround = 54,46%
Downround with broad based weighted average AD (share price in the seed round is repriced to the average “price” of all the company’s shares)
- AD dilution = 2,48%
- round dilution = 19,64%
- Founder ownership post downround = 53,12%
Downround with narrow based weighted average AD (share price in the seed round is repriced to the average price of all the shares issued in the seed round and downround)
- AD dilution = 8,56%
- round dilution = 19,64%
- Founder ownership post downround = 49,80%
Downround with full ratchet (share price in the seed round is repriced to share price in the downround)
- AD dilution = 28,57%
- round dilution = 19,64%
- Founder ownership post downround = 36,96%