Anti-dilution provisions are clauses included in the terms of a company's equity financing that protect investors from dilution of their ownership stake in the company due to future issuance of new shares. These provisions typically come into effect when a company raises additional funding at a lower valuation than a previous round of financing.
There are two main types of anti-dilution provisions: "weighted average" and "full-ratchet."
Weighted Average: Under this method, the number of shares issued in a subsequent round is adjusted upward to compensate for the lower valuation, but the total number of shares outstanding remains the same. This results in dilution for all shareholders, but the impact is less severe for early investors.
Full-ratchet: Under this method, the number of shares issued in a subsequent round is adjusted upward to compensate for the lower valuation, and the total number of shares outstanding increases. This results in dilution for all shareholders, but the impact is more severe for early investors.
Anti-dilution provisions are a way for investors to protect their investments, but they also limit the flexibility of the company to raise capital in the future. Companies may choose to avoid including these provisions in their financing terms or negotiate more favorable terms to balance out the trade-off.