When negotiating anti-dilution provisions in warrants—often accompanying equity or debt investments—both investors and companies must understand how to protect their interests. Anti-dilution provisions help ensure that warrant holders are not unfairly diluted when new shares are issued at lower prices or during structural corporate events. Use the following checklist as a practical guide to identify key considerations, common negotiation positions, and critical definitions. Test all formulas with sample calculations to ensure your final documentation is clear and enforceable.
Key Considerations for Anti-Dilution Provisions
1. Purchase Price Anti-Dilution
- Investor Position:
- Insist on adjustments for any future down-round issuances (shares issued below the warrant’s exercise price or current fair market value).
- Prefer strong protections like full ratchet or narrow-based weighted average adjustments.
- Consider dual triggers: adjust if the new issuance is below both the warrant price and fair market value.
- Reject or strictly limit de minimis exceptions; if included, ensure all down-round issuances count towards the threshold.
- For club deals or minority investments, consider pay-to-play provisions, stripping protections from non-participating investors in subsequent rounds.
- Company Position:
- Push for a broad-based weighted average or adjustments triggered only by issuances below current fair market value.
- Seek de minimis exceptions to avoid frequent minor adjustments.
- For early rounds, require pay-to-play from investors who want to maintain anti-dilution protections.
2. Warrant Shares Adjustment
- Investor Position:
- Ensure that if the purchase price is adjusted downward, the number of warrant shares increases proportionally.
- Use clear formulas and provide sample calculations in an exhibit to avoid ambiguity.
- No adjustments should result in a reduction of the total warrant shares.
- Company Position:
- Agree to proportional adjustments but ensure they are limited and clearly defined.
- Test the formula with examples to confirm it functions as intended.
3. Deemed Equity Issuances
- Investor Position:
- Count indirect issuances (e.g., options, convertible notes) as immediate equity issuances for anti-dilution adjustments.
- If the company resists, consider adjustments upon the actual exercise or conversion of those instruments.
- Include all potential shares issuable under these instruments, and require fair value determinations involving both parties.
- Company Position:
- Resist automatic adjustments from unexercised options or convertibles; only adjust when they convert into actual shares.
- Ensure fair value is determined by the board without undue investor control.
- Permit recalculations if options or convertibles expire without exercise.
4. Corporate Structural Anti-Dilution
- Investor Position:
- Include broad adjustments for stock splits, reverse splits, stock dividends, reorganizations, mergers, and asset sales.
- Require successor entities to assume warrant obligations, or give the investor the right to exercise pre-closing.
- Consider a catch-all provision for unforeseen corporate events.
- Company Position:
- Keep corporate anti-dilution provisions narrow and specific.
- Resist obligations to have successors assume the warrant.
- Oppose catch-all provisions and require explicit negotiations for any corporate events.
Important Definitions
Excluded Issuances
- Investor Position:
- Keep exclusions narrow—only a limited number of shares for officer and director incentive plans should be excluded from triggering adjustments.
- Company Position:
- Broaden exclusions to cover shares issued for strategic partnerships, financings, and acquisitions.
Common Stock Deemed Outstanding
- Investor Position:
- Favor a narrow definition (actual outstanding common shares only) for a more favorable anti-dilution calculation.
- Company Position:
- Prefer a fully diluted approach including all reserved shares for a broader base, reducing the impact of adjustments.
Fair Market Value
- Investor Position:
- For triggers based on fair market value, seek joint determination or use an independent appraiser if no board influence exists.
- Specify valuation methodologies and test with examples.
- Company Position:
- Keep fair market value determinations under board control.
- If an independent appraiser is used, share costs and ensure finality of the appraisal.
Additional Provisions
Certificates and Notices
- Investor Position:
- Request written notice after any adjustment or prior to structural events.
- At minimum, secure the right to request periodic certifications of exercise price and warrant shares.
- Company Position:
- Resist automatic notices; allow periodic certification requests instead.
Dividends and Distributions
- Investor Position:
- Seek a pro rata share of dividends or distributions as if the warrant were already exercised.
- Company Position:
- Limit the investor’s rights to dividends until the warrant is actually exercised.
Purchase and Preemptive Rights
- Investor Position:
- Include broad rights to participate pro rata in future issuances to maintain ownership percentage.
- Do not rely solely on purchase/preemptive rights as substitutes for price adjustments in a down round.
- Company Position:
- Offer purchase or preemptive rights (requiring additional investment) rather than price adjustments.
- Expand excluded issuances to reduce required participation opportunities for investors.
Veto Rights Over Future Equity Issuances
- Investor Position:
- Seek approval rights over future equity issuances if anti-dilution protections are limited.
- Company Position:
- Resist giving veto rights, as these can limit future fundraising options.
Final Tips
- Test Your Formulas: Attach sample calculations as exhibits to the warrant, verifying that both price and share adjustments function correctly.
- Be Specific: Define triggers, valuation methods, and calculation formulas in detail to reduce ambiguity.
- Balance Interests: Investors aim for robust protection, while companies seek flexibility. Aim for clear, fair, and mutually acceptable terms.
By following this checklist and carefully negotiating each point, both investors and companies can craft anti-dilution provisions that protect their interests while maintaining clarity and fairness.
