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Antidilutive Provisions

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Moneyzine Editor
2 mins
January 5th, 2024
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Antidilutive Provisions

Definition

The term antidilutive provision refers to agreements that protect investors from dilution in earnings or ownership that can occur when additional shares of common stock are issued. Convertible bonds and preferred stock, warrants and stock options can all lead to dilution of earnings as well as ownership in a corporation.

Explanation

Companies issue additional shares of common stock for a number of reasons. They're oftentimes issued as part of a comprehensive employee compensation program that includes stock option plans and warrants. They can also be issued as part of a merger agreement, or result from a conversion feature attached to preferred stock or bonds. These arrangements can become dilutive when the holder exercises a conversion right to receive shares of common stock. Once converted, the total number of shares issued by the company increases, and the ownership of all shareholders is reduced.

Also known as subscription rights or preemptive privileges, antidilutive provisions protect the existing stockholders from dilution by providing them with the right to maintain their ownership stake in the company through the purchase of a proportionate number of shares in the future. A ratchet provision allows existing investors to retain their ownership in the event new shares of stock are issued at lower prices, while a broad-based weighted average provision allows existing investors to purchase shares at a price that reflects both the original price per share and the price per share of new issues.

Example

Perhaps the most notorious example of investor dilution in the venture capital world is attributed to Facebook's Mark Zuckerberg. At one point, Eduardo Saverin (one of the company's original founders) owned roughly 34% of TheFacebook stock. In 2005, Mark Zuckerberg, along with Sean Parker, created a new company and authorized additional shares of stock to be issued at one-half cent per share without Saverin's consent or knowledge. These additional shares were then divided among existing partners, excluding Saverin. In doing so, his ownership of the company was diluted from 34% to less than 10%. Zuckerberg now had complete control over the operation of what would eventually become Facebook.

Related Terms

Convertible Preferred Stock
The term convertible preferred stock is used to describe one of several classes of preferred stock that can be issued by a company. To add to the marketability of this investment, convertible preferred stock provides the holder with the right to exchange this investment for shares of common stock.
Moneyzine Editor
Moneyzine Editor
January 12th, 2024
Convertible Bonds
The term convertible bond refers to an indenture issued by a company that is exchangeable for shares of common stock or the equivalent amount of cash. Convertible bonds are considered a hybrid security, since they contain both debt and equity features.
Moneyzine Editor
Moneyzine Editor
January 12th, 2024
Cost of Common Stock
The term cost of common stock refers to a calculation that allows the investor-analyst to understand how expensive it is for a company to issue common stock. The cost of common stock is also one of three metrics used to calculate a company's cost of capital
Moneyzine Editor
Moneyzine Editor
January 12th, 2024
Earnings per Share (EPS)
The financial ratio earnings per share, or EPS, is perhaps the single most popular variable used by analysts and investors to evaluate the profitability of a company. EPS measures the profitability of a company on a per share basis.
Moneyzine Editor
Moneyzine Editor
January 16th, 2024
Dilutive Securities
The term dilutive securities refers to financial instruments that are not in the form of common stock but can be converted to common stock. Examples of dilutive securities include convertible bonds and preferred stock, warrants and stock options.
Moneyzine Editor
Moneyzine Editor
January 16th, 2024
Antidilutive Securities
The term antidilutive securities refers to financial instruments that are not in the form of common stock, but when converted into common stock will increase earnings per share.
Moneyzine Editor
Moneyzine Editor
January 5th, 2024

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