Definition: Anti-dilution provisions allow investors to avoid diluting their holdings in a company by purchasing additional shares when needed. This is in contrast to debt financing, under which investors are forced to buy shares at a lower price if they wish to maintain their percentage ownership. Anti-dilution provisions are typically found in shared-ownership structures where investors represent less than 10% of the equity capital of a company. Shareholders also have the option of voting on an issue of callable shares if certain conditions are met.
Anti-dilution provisions are found in various terms and conditions that are designed to stop you from being overcharged or taken advantage of. These anti-dilution provisions are designed to compensate the issuer for carrying out its role in payment processing by preventing fraudulent or illegal transactions from taking place. There are three main aims of anti-dilution provisions: prevent fraud, reduce costs and improve the operational efficiency of payment institutions.
When there are too many shares outstanding, the owners of those shares have an incentive to maintain their stake by purchasing additional shares or voting for the same individual as a shareholder. A company when issues more shares to existing shareholders without giving them a corresponding increase in the number of votes they own can result in dilution. In either case, this can diminish the value of an investor’s investment because his or her interest in the business is reduced compared with those of other shareholders.
Stock dilution occurs when Shares of a company’s stock become legally unavailable for sale after the close of business on a particular day. The resulting effect is that the market price per share of the company’s stock typically decreases because the stock was legally unavailable for sale when the Options are exercised. Consider, if you purchase 100 Shares of a company at the original price of $10 per share and a court issues an order preventing you from selling your shares on the OTC market after 3 days, your purchase price for the 100 Shares would be $7.50 (after dilution).
Types of Anti-dilution provisions
Ratchet provisions are important for two reasons: price discovery and working capital management. Suppose you have a business with a low capacity to issue new shares and unlimited investing options. In that case, ratchet provisions will allow you to raise the price of your outstanding preferred stock at least in part by pricing lower than it would be if all options were exercised simultaneously. By increasing the price of your shares early, you prevent dilution to your existing stockholders while enabling you to obtain additional financing at a lower cost.
Weighted Average method
The weighted average method uses a formula to determine the new conversion price.
New Conversion Price = O x (A1 + A2) / (A1 + C)
O – Old conversion price
A1 – Shares outstanding before new issue
A2 – Consideration received with the new issue
C – New shares issued
The full ratchet provision reduces dilution. It is better suited to shares worth more today and will be worth more tomorrow than if the share were fully issued today, sold at today’s market price, and redeemed tomorrow. The weighted average method is best suited to shares that are more likely to be traded today than tomorrow and have less intrinsic value than a higher market price/book value. It protects someone who invested in the company then (and still) owns low-priced insurable assets, and it gives preferred shareholders the right to convert their preferred stock at any time before it becomes fully exercisable.