Legal Definitions - antidilution provision

An antidilution provision is a contractual clause, typically found in agreements for convertible securities (such as convertible bonds or convertible preferred stock), designed to protect investors. Its purpose is to ensure that the value of their right to convert these securities into common stock is not unfairly reduced or "diluted" by certain corporate actions. These actions often include events like stock splits, stock dividends, or other transactions that increase the total number of outstanding shares without a corresponding increase in the company's overall value. Essentially, it adjusts the conversion terms to maintain the original economic interest and potential ownership percentage of the convertible security holder.

• Example 1: Stock Split

  Imagine "TechInnovate Inc.," a growing software company, issues convertible notes to early-stage investors. Each note can be converted into 1,000 shares of common stock. A year later, TechInnovate's stock price has risen substantially, and the company decides to perform a 2-for-1 stock split to make its shares more affordable and liquid for new investors. Without an antidilution provision, the noteholders would still only be able to convert their notes into 1,000 shares, even though each individual share is now worth half its pre-split value. However, with an antidilution provision, the conversion terms would automatically adjust. Each note would now convert into 2,000 shares, effectively doubling their potential common stock ownership and preserving their original percentage stake in the company after the split.

• Example 2: Stock Dividend

  "GreenEnergy Solutions" has issued convertible preferred stock to a venture capital firm, with each preferred share convertible into 200 shares of common stock. To reward its existing common shareholders, GreenEnergy Solutions later declares a 5% stock dividend, meaning every common shareholder receives an additional 5% of their existing shares for free. An antidilution provision in the preferred stock agreement would ensure that the venture capital firm's conversion rights are protected. The provision would adjust the conversion ratio, so the preferred shares could now be converted into 210 shares of common stock (200 shares + 5% of 200 shares). This adjustment prevents the dilution of the venture capital firm's potential ownership percentage that would have occurred due to the increased number of common shares outstanding from the stock dividend.

• Example 3: Issuance of New Shares at a Lower Valuation ("Down Round")

  "BioPharma Innovations," a startup, raises its initial funding by selling convertible preferred stock to investors at $5 per share, convertible into common stock on a 1:1 basis. Six months later, due to unexpected delays in clinical trials, BioPharma Innovations needs to raise additional capital but can only do so by selling new preferred stock to new investors at a significantly lower price of $2.50 per share. A robust antidilution provision (often referred to as a "full-ratchet" or "weighted-average" provision in this context) would protect the original investors. It would adjust their conversion price downwards, meaning their initial preferred shares would now convert into *more* than one common share for each preferred share. For instance, if it's a full-ratchet provision, their conversion price might drop to $2.50, effectively doubling the number of common shares they would receive upon conversion, compensating them for the dilution caused by the new, lower-priced share issuance and preserving the relative value of their initial investment.