{"id":2725,"date":"2022-03-22T07:50:46","date_gmt":"2022-03-22T07:50:46","guid":{"rendered":"https:\/\/demo.samistilegal.in\/?p=2725"},"modified":"2022-03-22T07:50:48","modified_gmt":"2022-03-22T07:50:48","slug":"anti-dilution-an-investors-right-or-a-companys-requirement","status":"publish","type":"post","link":"https:\/\/demo.samistilegal.in\/?p=2725","title":{"rendered":"Anti-Dilution: An Investor\u2019s right or a Company\u2019s requirement?"},"content":{"rendered":"\n

Introduction to the concept of Anti-Dilution<\/strong><\/p>\n\n\n\n

An investor\u2019s decision to invest in a company is, usually, driven by the company\u2019s future
potential. If it is subsequently found that the company has failed to meet its expected
potential, a valuation dip occurs. This often leads to a down round which refers to the
issuance of shares at a lower price. Consequently, the investment made by investors suffers as
the value of shares held by such investors witnesses a downfall.<\/p>\n\n\n\n

In consideration of the decrease in the investor\u2019s shareholding percentage owing to fresh
investment in the company by new investors at a lower price, anti-dilution provisions are
negotiated by the investors prior to making an investment in the company. However, anti-
dilution provisions are significant not only from the investor\u2019s perspective but also from that
of the company point of view. Often, anti-dilution protection is offered by companies to
attract investors in the equity round to ensure long-term investment. In other words, without
providing anti-dilution protection, it might be difficult for companies to find investors and
raise funds.<\/p>\n\n\n\n

Anti-dilution protection is a standard clause in transactional agreements, however, it is
critical for both, the investor and the company, to negotiate its terms. Generally, there are two
types of anti-dilution: (i) Full Ratchet, being especially investor favouring; and (ii) Weighted
Average.<\/p>\n\n\n\n

  1. Full Ratchet Method<\/strong><\/li><\/ol>\n\n\n\n

    Under the Full Ratchet method, the shareholding of the existing investor is adjusted on the
    basis of the reduced per share price offered by the Company as part of the down round. In
    other words, the price of the shares or conversion price of the existing investor will be revised
    to the per share price at which the new shares are being issued in the down round.<\/p>\n\n\n\n

    Consequently, additional shares are issued to the existing investor to cover for the price
    adjustment without requiring the investor to make any further payments towards such
    additional shares being issued. Thus, the effect of this method would be such that the existing
    investor is assumed to have originally invested in the Company at the down round valuation
    and its shareholding percentage is accordingly adjusted.<\/p>\n\n\n\n

    It is pertinent to note that under this method, neither the number of shares held by the existing
    investor nor the number of shares offered to the new investors are considered. The only factor
    that is taken into account is the new per share price at which shares are offered to the new
    investors. Then, the new per share price is applied to all shares held by the existing investor.<\/p>\n\n\n\n

    Additionally, it is noticed that under the Full Ratchet method, the existing investors will
    benefit from an anti-dilution clause and the company will be compelled to issue more and
    more shares in order to protect the existing investor\u2019s shareholding percentage.<\/p>\n\n\n\n

    Under this method, the company, over time, may lose control over issuance of shares.
    Therefore, this method is considered investor-friendly and harsh on the company. Further, it
    may lead to dilution of the founders\u2019 shareholding percentage to a great extent. In light of
    this, the Full Ratchet method of anti-dilution is rarely implemented.<\/p>\n\n\n\n

    2. Weighted Average Method<\/strong><\/p>\n\n\n\n

    In comparison to the Full Ratchet method, companies prefer the Weighted Average method to
    provide anti-dilution protection to its investors. The rationale behind this is that the Weighted
    Average method uses a systematic formula for adjustment of shares, thereby, limiting dilution
    in a manner that is beneficial to both, the existing investors and the company. It can be
    considered as a mechanism wherein the shares of the Investor are converted based upon the
    conversion price which is the average between the existing share price and down round share
    price. Thus, this method is viewed as a more balanced and fair mechanism.<\/p>\n\n\n\n

    Factors like the original per share price at which shares were issued to the existing investors,
    and the number of shares offered to the existing and new investors are taken into account in
    the formula to determine the appropriate price adjustment. The concerned adjusted
    conversion price is, then, used to drive up the existing investors\u2019 shareholding percentage in a
    down round. The adjustment, usually, is very modest if the number of shares offered to the
    new investor are less and vice versa if the number is more.<\/p>\n\n\n\n

    Further, the Weighted Average method is classified into two methods namely, (i) Broad-
    based Weighted Average method; and (ii) Narrow Weighted Average method. The basic
    difference between the two methods is that the former takes into account the entire amount of
    outstanding shares for the adjustment, whereas, the latter may be tailored to exclude certain
    classes of shares. Moreover, Broad-based Weighted Average method is commonly used as
    there is a larger down round adjustment under Narrow Weighted Average method.<\/p>\n\n\n\n

    Implementation of an Anti-Dilution Provision<\/strong><\/p>\n\n\n\n

    Even though it is considered standard to have an anti-dilution provision in the definitive
    agreement, the implementation of the provision has led to the occurrence of several complex
    legal implications for the concerned company to deal with.<\/p>\n\n\n\n

    It may be noted that any further issue of shares by an Indian company shall occur pursuant to
    the provisions of the Companies Act, 2013 (the “Act”) and, if applicable, also pursuant to the
    provisions of the Foreign Exchange Management Act, 1999 along with its rules and
    regulations. Wherein any share is issued to a foreign investor, the same has to be issued in
    compliance with the pricing guidelines under Foreign Exchange Management (Transfer or
    Issue of Security by a Person Resident Outside India) Regulations, 2017
    (“FDI\u00a0Regulations”). As per FDI Regulation\u2019s pricing guidelines, such capital instruments
    has to be priced as per any internationally accepted pricing methodology for valuation on an arm’s length basis and duly certified by a chartered accountant or a SEBI registered merchant
    banker or a practicing cost accountant in case of an unlisted company.<\/p>\n\n\n\n

    On the other hand, while we look into the case of issuance of convertible instruments, it may
    be observed that the price\/conversion formula of the convertible instrument has to be
    determined upfront at the time of issue and that the price at the time of conversion should not
    in any case be\u00a0lower than the fair value, at the time of issuance of such instruments, in
    accordance with the FDI Regulations.<\/p>\n\n\n\n

    In consideration to the aforementioned observations, it may be crystal clear that the
    enforcement and implementation of anti-dilution provisions whilst issue of shares pursuant to
    the same (especially in case of foreign investors) carries a lot of complexities. Furthermore,
    there may also exist critical complexities and high taxability obligations in these types of
    transaction. Hence, one is always suggested to consult experienced professional prior to
    entering into and conducting such transaction deals.<\/p>\n\n\n\n

    Conclusion<\/strong><\/p>\n\n\n\n

    In light of the COVID-19 pandemic, our country\u2019s economy has been hit hard resulting in a
    downfall of company valuations. Such circumstances have forced companies to issue shares
    at lower prices, therefore, diluting the shareholding percentage of existing investors. The
    situation demands heavy diligence on part of investors while negotiating anti-dilution rights.
    It has become extremely significant for both the investors and companies, to hypothecate
    different scenarios and comprehend the true impact of distinct types of anti-dilution
    provisions.<\/p>\n\n\n\n

    Further, it is pertinent for investor to note that, may it be the less preferred Full Ratchet
    method or the company-friendly Weighted Average method, protection from dilution can be
    provided using different mechanisms. In this regard, companies may choose adjustment by
    way of: (a) issuance of additional shares to the existing investors; (b) transfer of shares from
    founders to the investor; (c) in case of convertible instruments, by adjusting the conversion
    price as per previous prices; (d) buy back of shares held by existing investors; or (e) by
    reducing the sale proceeds of the promoters or other shareholders. However, the most
    commonly used mechanism is issuance of additional shares to the existing investor.<\/p>\n\n\n\n

    Author<\/strong>: Dippyaman Bhattacharya, Associate.<\/p>\n\n\n\n

    Disclaimer: The content of this article is intended to provide a general guide to the subject matter and that the same shall not be treated as legal advice. For any queries, the author can be reached at\u00a0<\/em><\/strong>dippyaman@demo.samistilegal.in<\/p>\n","protected":false},"excerpt":{"rendered":"

    Introduction to the concept of Anti-Dilution An investor\u2019s decision to invest in a company is, usually, driven by the company\u2019s futurepotential. If it is subsequently found that the company has failed to meet its expectedpotential, a valuation dip occurs. This often leads to a down round which refers to theissuance of shares at a lower […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[8],"tags":[],"class_list":["post-2725","post","type-post","status-publish","format-standard","hentry","category-articles"],"_links":{"self":[{"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=\/wp\/v2\/posts\/2725","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=2725"}],"version-history":[{"count":1,"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=\/wp\/v2\/posts\/2725\/revisions"}],"predecessor-version":[{"id":2726,"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=\/wp\/v2\/posts\/2725\/revisions\/2726"}],"wp:attachment":[{"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=2725"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=2725"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/demo.samistilegal.in\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=2725"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}