Weighted Average Antidilution . . .
refers to a form of antidilution protection that is
commonly used by venture capital investors to prevent the value of
their shareholdings from being unfairly reduced by later share sales
at lower prices. The weighted average method uses a formula to
determine the dilutive effect of a later sale of cheaper securities
and grants the investor enough extra shares for free to offset that
dilutive effect.
A common weighted average formula multiplies the
number of shares of company stock outstanding, including the protected
venture investor’s shares, by the price per share paid by the
venture investor for his shares, adds to that product the amount of
the new investment (number of new shares times the new per share price) and
divides the sum by the total number of shares outstanding after the
new investment. The result of this calculation gives a new price per
share for the protected venture investor that is then divided into the
dollar amount he invested to determine the total number of shares he
should have. The difference between this number and the number of
shares the venture investor already owns is the number of new shares
the venture becomes entitled to receive for free.
The weighted average antidilution method is usually
more favorable to management shareholders than the ratchet method
described earlier. Under that method, the protected investor is
entitled to get enough free shares to reduce his price per share to
the same price paid by the later investor regardless of the number of
shares sold to the later investor. (See: Ratchets.) The following
example illustrates how great the difference can be between the
operation of a ratchet and a weighted average antidilution provision.
Assume that an investor buys 300,000 shares of company
stock for $2 per share when management owns 700,000 shares. A later
investor buys 200,000 shares from the company for $1 per share. A
ratchet would give the first investor 300,000 new shares for free in
order to reduce his average price per share to $1.
The weighted average method issues far fewer new
shares to the protected investor. Under that method, the first
investor’s 300,000 shares are added to management’s 700,000 shares
and then multiplied by $2. The $2,000,000 product of this calculation
is then added to the $200,000 paid by the second investor giving a sum
of $2,200,000. This amount is divided by the total number of shares
outstanding after the second sale, 1,200,000, to give the new average
price for the first investor. That price is $1.83 per share. When
divided into the $600,000 invested by the first investor this yields
327,869 total shares to which the first investor is entitled,
requiring the company to issue him 27,869 free shares.
The chart below compares how the two antidilution
methods fared in the example. The difference in results from the two
methods would be even more dramatic if fewer shares were sold to the
second investor.
-
Comparison of Antidilution Methods
| |
Weighted Average |
Ratchet |
| Shares bought by investor |
300,000 |
300,000 |
| Free shares to investor |
27,869 |
300,000 |
| Total investor shares |
327,869 |
600,000 |
| Total outstanding shares |
1,227,869 |
1,500,000 |
| Average investor share price |
$1.83 |
$1.00 |
| Percent owned by investor |
26.6 |
40.0 |
| Percent owned by management |
57.0 |
46.6 |
| Percent owned by 2nd investor |
16.4 |
13.4 |
See: Antidilution
Provisions, Dilution
(Percentage), Ratchets.
