Typically dilution will be addressed in the classification of stock series. Anti-dilution clauses always appear in a term sheet - initial investers usually insist on it.
Anti-dilution protection would give the original investor rights to purchase an amount of stock of the new class to enable his interest to stay consistent. Alternatively a diluted average approach would convert the share value but not allow for the purchase of additional shares.
For instance if you issued 100 shares of Class A stock for 10,000 each the initial valuation would be 1,000,000. And if investor X owns 60 shares, investor X owns a majority of the company.
If you then issued another 100 shares of Class B (assume they carry the same ownership interest) stock for 5,000 each, the valuation for the company becomes 1,500,000.
Under an anti-dilution provision Investor X (a Class A holder) would have the right to 60 shares of Class B stock and his 60 shares of Class A stock would convert to 120 giving him a total of 180 (60+120) shares valued at $5,000 and keeping his ownership interest consistent. 180/300 = 60%.
Under a diluted approach there would now be 200 converted shares of Class A stock and 100 shares of Class B stock. All stock would move to the lower 5,000 valution and Investor X would own 120 shares (because his interest is now worth twice as many shares). However Investor X has no right to purchase Class B shares so hw sould own 120 shares of Class A stock. 120/300 is .40 so Investor X now only owns 40% of the company.
One way to achieve this result is to include a clause in the term shee that says:
"In the event that the Company issues additional securities in the future at a purchase price less than the Series A offer price, the additional securities class shall be adjusted in accordance with the following formula: Class A value will be reduced to the price at which the new share class are issued at and any additional shares that result from the lower price conversion will be distributed accordingly. Class A holders will have no guranteed right to purchase any quantity of new securities classes offered. This will apply to all future classes issued."
This is a complicated matter and I am not providing legal advice just information. A key take away from this discussion is surely to use a banker for the calculations and a lawyer to business lawyer licensed in your jursidiction to negotiate this clause for you.
If my answer was satisfactory to you please accept the answer so I can receive credit for my response and please leave feedback if you found the information helpful. BONUSES are appreciated.Thank you.--------------------------------------------------------------------- AGAIN THE INFORMATION PROVIDED ABOVE IS NOT LEGAL ADVICE AND IS NOT IN ANY WAY INTENDED TO SUBSTITUTE FOR THE JUDGMENT AND COUNSEL OF AN ATTORNEY LICENSED IN YOUR JURISDICTION. THE ABOVE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY. AS A RESULT NO ATTORNEY-CLIENT RELATIONSHIP IS FORMED. --------------------------------------------------------------------
DISCLAIMER: Answers from Experts on JustAnswer are not substitutes for the advice of an attorney. JustAnswer is a public forum and questions and responses are not private or confidential or protected by the attorney-client privilege. The Expert above is not your attorney, and the response above is not legal advice. You should not read this response to propose specific action or address specific circumstances, but only to give you a sense of general principles of law that might affect the situation you describe. Application of these general principles to particular circumstances must be done by a lawyer who has spoken with you in confidence, learned all relevant information, and explored various options. Before acting on these general principles, you should hire a lawyer licensed to practice law in the jurisdiction to which your question pertains.
The responses above are from individual Experts, not JustAnswer. The site and services are provided “as is”. To view the verified credential of an Expert, click on the “Verified” symbol in the Expert’s profile. This site is not for emergency questions which should be directed immediately by telephone or in-person to qualified professionals. Please carefully read the Terms of Service (last updated February 8, 2012).