An anti-dilution provision is a protective measure typically included in investment agreements, such as convertible securities or stock purchase agreements, to safeguard the rights of existing investors in the event of future issuances of securities at a lower price than the price at which the existing investors made their investment. The primary purpose of an anti-dilution provision is to mitigate the impact of dilution on the ownership percentage and economic interests of existing investors.

There are two main types of anti-dilution provisions:

1. **Full Ratchet Anti-Dilution:**
– In a full ratchet anti-dilution provision, if the company issues new shares at a price per share lower than the existing investors’ original purchase price, the conversion or exercise price of the existing investors’ securities is adjusted downward to the new, lower price. This adjustment is typically done on a one-for-one basis.

– This means that the existing investors receive additional shares (or their existing shares are adjusted) to compensate for the decrease in the valuation of the company. Full ratchet anti-dilution is more favorable to existing investors but can be harsh for the company and its other shareholders.

2. **Weighted Average Anti-Dilution:**
– The weighted average anti-dilution provision is more common and less severe than the full ratchet. It takes into account both the price and the number of new shares issued in the dilutive event. The formula for the adjusted conversion or exercise price is based on a weighted average of the old and new prices, considering the number of old and new shares.

– The weighted average anti-dilution provision is considered more equitable because it doesn’t result in as significant a downward adjustment as the full ratchet. It provides some protection to existing investors without excessively punishing the company for raising additional capital at a lower valuation.

Anti-dilution provisions are crucial negotiation points in investment agreements, and their presence and terms can significantly impact the risk-reward dynamics for both existing investors and the company seeking additional funding. Startups and early-stage companies often use anti-dilution provisions to attract investors by offering protection against future dilution. However, the inclusion of these provisions can also affect the company’s ability to raise capital in subsequent financing rounds.