The broad-based weighted average anti-dilution protection is a mechanism to adjust the conversion price of the preferred stock held by investors when a company issues new shares at a price lower than the previous rounds (a down round). This protection is meant to reduce the dilutive effect on the existing preferred shareholders.
Here’s how the broad-based weighted average works in practice:
When new shares are issued at a price lower than what the existing preferred shareholders paid, the broad-based weighted average formula is used to adjust the conversion price of the preferred shares. This conversion price dictates how many common shares the preferred shares can be converted into. By adjusting this price downward, the preferred shareholders can convert their shares into more common shares than before, thus partially offsetting the dilution of their equity stake.
The formula for calculating the new conversion price typically includes the following variables:
- Current Conversion Price: This is the price at which the preferred shares currently convert into common shares.
- Number of Shares Previously Outstanding: This is the total number of common shares that were outstanding before the new issue (it can include all common shares, all options and warrants that are in-the-money, and all convertible securities).
- New Issuance Price: This is the price per share at which the new shares are being sold.
- Number of New Shares Issued: This is the number of new shares being issued in the down round.
The broad-based weighted average calculation takes into account the entire capital structure, which makes it less punitive than the full ratchet method because it does not adjust the conversion price as dramatically. Instead, it strikes a balance between the interests of new investors, existing investors, and the company.
The resulting new conversion price will always be higher than the new issuance price, meaning that existing preferred shareholders are still diluted, but less so than they would have been without the anti-dilution protection.
The broad-based weighted average provision is seen as more founder-friendly and is generally preferred by companies because it allows for a more equitable adjustment among stakeholders. It recognizes the contribution of both new and existing investors, without overly penalizing either party in the event of a down round.