Broad-based weighted average anti-dilution protection is a provision commonly found in venture capital financing agreements. It's designed to protect investors from dilution in the event that the company issues new shares at a price lower than what the investors previously paid (i.e., in a down round). Instead of preventing dilution entirely, this provision adjusts the conversion price of the preferred shares held by the investor, which in turn affects how many common shares they can convert into.
Here's a breakdown of how broad-based weighted average anti-dilution protection works:
1. Conversion Price Adjustment: The provision adjusts the conversion price of the investor's preferred shares. The new conversion price is calculated based on a weighted average of the old conversion price and the price at which the new shares are issued.
2. Broad-Based: The term "broad-based" means that the weighted average calculation takes into account all of the company's outstanding shares, including common shares and all series of preferred shares. This is in contrast to a "narrow-based" calculation, which might only consider a subset of the shares.
3. Effect: By adjusting the conversion price downward, the investor gets the right to convert their preferred shares into more common shares than before. This compensates for the dilution effect of the down round.
4. Fairness: The broad-based weighted average method is generally seen as more equitable than other anti-dilution provisions, like full ratchet anti-dilution. In the full ratchet method, the conversion price of the investor's shares is simply adjusted down to the new issuance price, regardless of the number of new shares issued. This can result in significant dilution for founders and other shareholders. In contrast, the broad-based weighted average method considers both the price and the number of new shares being issued, leading to a more balanced adjustment.
5. Formula: The exact formula for the adjustment can vary, but it typically involves factors like the original conversion price, the new issuance price, the number of shares previously outstanding, and the number of new shares being issued.
In essence, broad-based weighted average anti-dilution protection provides a middle ground. It offers protection to investors without being overly punitive to the company's founders and other shareholders. It's a common provision in venture deals because it strikes a balance between the interests of different stakeholders.