Should I give my seed investors anti-dilution protection?
Original question from Quora:
“My team and I are raising our first round for our crowdsourcing website at a $1mm valuation. We have an investor who is interested in purchasing 5% of the company under the condition that his stock will not be diluted at any time. We are considering a counteroffer at twice the valuation considering the anti-dilution provision. Is this common? What are the implications of anti-dilution? How will it affect future financing rounds? Should we continue the conversation considering anti-dilution, or try a different counteroffer?”
What this investor is seeking is called “permanent, full-ratchet, anti-dilution protection”, and that is neither (a) in line with the market, nor (b) practical. Even if you were willing to give it to him, it is highly, highly unlikely to stand up beyond the next financing round, because there’s no way your next investor is going to take a dilution hit for this first one. That’s why anti-dilution provisions are typically only applicable to the next financing.
So, no, you simply can’t give him what he wants. (Assuming that the next investor wouldn’t stomach it, there are only two possible outcomes: A: the new investor forces the original one to waive it, or B: the new investor walks away from the deal.)
Instead, let me suggest that you offer “weighted average anti-dilution protection” to the next equity round. That is fair and reasonable, and should provide an appropriate level of comfort to this investor.
Written by David S. Rose
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