A fave of venture capitalists looking to protect their investments, an anti-dilution adjustment is a formula that adjusts the price of a convertible security (such as convertible debt note) when it changes into another form of equity through magic or for some other reason that’s a lot less interesting. The general purpose is to protect investors against price dilution.
So if early investors paid a lot more per share than what the stock is currently selling for, anti-dilution adjustment would protect those early supporters from losing money and letting others swoop in and take control of the company on the cheap. This can happen when suddenly more shares of the company go up for sale, making an investor’s percentage stake in the company significantly lower. The anti-dilution adjustment keeps the investor’s percentage stake in the company the same, even if the value of the stock or amount of available stock options has changed.
Anti-dilution protection is one of the main things that is different about stock sold to investors from common stock generally held by founders and employees.
The “weighted average” formula adjusts the conversion rate using different variables like the number of shares involved with the dilutive issuance and the price of the dilutive issuance. The “ratchet” method reduces the conversion price to the price paid for the dilutive issuance, no matter how many shares were part of the dilutive issuance.
Glad that anti-dilution adjustment is in place or I would have just gone from owning 20% of the doll factory to just 10% in one swoop.