A shareholder agreement is a legally binding contract between the shareholders of a company that outlines the rights, obligations, and responsibilities of each shareholder. One of the critical provisions that a shareholder should include in the agreement is the anti-dilution clause.
Anti-dilution is a mechanism aimed at protecting a shareholder`s ownership percentage in the company from being diluted by the issuance of new shares. In essence, it prevents the dilution of the shareholder`s ownership interest by giving them the right to purchase additional shares at a reduced price in the event that new shares are issued at a lower price than the current market value.
The anti-dilution clause can be critical for protecting shareholders, particularly in situations where new shares are issued at a lower value than the original shares. As a result, the shareholder`s percentage ownership in the company would decrease, and they would lose some control over the company`s affairs.
The anti-dilution provision typically provides for either a full-ratchet or a weighted-average approach. Full-ratchet anti-dilution is the most aggressive approach, where the conversion price is adjusted to the lowest price paid for the new shares. In contrast, the weighted-average approach is less extreme, and it takes into account the overall share price and the number of new shares issued.
Investors should be aware that the anti-dilution clause may be waived by the majority of shareholders or the board of directors. This is particularly true if the company is in dire financial straits, and a new investor is required to keep the company afloat.
In conclusion, the anti-dilution clause is a vital protection mechanism for shareholders that should be included in a shareholder agreement when forming a company. It is crucial to understand the implications of this clause and how it works to protect shareholder interests. As such, it is vital to engage the services of a professional legal advisor with experience in drafting such agreements.