Investments can go wrong sometimes, causing them to lose value instead of the usual gaining of weight.
This is where Anti-Dilution rights come in. Dilution can be seen as an investor’s shares decreasing to the issuance of new shares.
Anti-Dilution rights are clauses designed into convertible preferred stocks and various other options. It helps shield investments from potentially losing value.
Anti-Dilution rights can also be referred to as subscription rights, preemptive rights, subscription privileges, or anti-dilution clauses.
How Does Anti-Dilution Right Help?
If new shares are issued, an anti-dilution clause helps investors to own the exact percentage that they previously owned rightfully. Hence protecting the investor’s equity stake from dilution.
Usually, when a company issues new shares, the number of outstanding shares in the company increases. But despite this, the investor still has the same number of shares they had before the rise. What this leads to is a decrease in the investor’s percentage ownership.
When Can Anti-Dilution Clauses Be Used?
Anti-dilution clauses can be used by companies whenever they issue convertible stock. These clauses help keep an investor’s percentage intact by adjusting the conversion price between various convertible securities such as preferred shares, and corporate bonds.
Types of Anti-Dilution Rights
Price-based anti-dilution rights: When carrying out their investment procedures, investors negotiate anti-dilution clauses as part of their investment. This action helps these investors offset whatever effects dilution may cause in the long run of their investment.
There are two types of price-based anti-dilution rights. They include:
- Weighted Average: Weighted average is a type of price-based clause that adjusts the conversion ratio.
During this conversion, the weighted average uses an amount that offsets the dilution caused by the issuance of new shares.
Under this price-based clause, the new conversion price is determined through a formula.
A new conversion price (NCP) is found by solving this equation.
NCP= O(Old conversion price) x (A+B)÷(A+C)
A = Outstanding shares before issuance
B = Consideration received due to new shares issuance
C= New shares issued
- Full Ratchet; This type of price-based anti-dilution right focuses on protecting investors who own convertible securities.
The clause allows investors to convert at the lowest possible sale price offered. It lowers the cost of the purchase stock to the actual price at which new shares are issued in later rounds of the investment.
Contractual anti-dilution rights: While carrying out their investment procedures, some investors negotiate their rights. This option allows them to receive additional shares for no extra charges.
Contractual anti-dilution right helps protect investors’ percentage interest from dilution in the event of new shares issuance. Investors receive additional shares irrespective of the price of the new shares and at no cost.
Dilution can happen if the percentage of an investor’s stake in an organization decreases due to the total number of outstanding shares.
When this occurs, an anti-dilution clause helps shield investors’ investment from damage. Anti-dilution rights are essential for every investor as the main aim is to prevent investors’ ownership of a company from decreasing.