Delivered August 15, 2019. Contributor: Michelle A.
To understand how angel investors can protect themselves from dilution of their investment when new investors get involved in an investment.
An anti-dilution provision is used by investors to protect from unfair dilution of their investment. In basic terms, the provision states that if a later round of investing happens at a lower price than the original investor paid, the purchase price of the original investor is changed retroactively to the lower price, which results in that person holding more shares.
The anti-dilution provision can be in place for all stock or a portion of the stock. There are pros and cons of each, but it is more common for these provisions to be in place for a portion of the stock only.
Another risk for early investors is that later investors will have liquidation preferences written into their contract. This means that they get preference in receiving money back if the company goes under or is sold. If the original angel investor has not written this into their contract, they risk not getting their money back.
Most startup investors own preferred stock rather than common stock. This distinction gives the original investors more rights at payout.
One case study found stated that excess dilution can be avoided by raising funds via private debt rather than selling more equity.
Only the project owner can select the next research path.