We are all familiar with the modified ratchet and full ratchet anti-dilution provisions that relate to subsequent down rounds in the financing of start-up and emerging growth companies. A new twist on anti-dilution provisions is raising its head and, according to the Wall Street Journal, becoming more and more common. See “Startups Boosting the Risk” published on December 26, 2013. Some start-ups and emerging growth companies are now providing anti-dilution protection by guaranteeing investors a certain price per share on the initial public offering of the company’s stock. If the initial public offering price does not reach the designated price, the investor is entitled to additional shares in order to receive the value it would have received if the initial public offering price had reached the designated price. It seems to me that only companies with little or no leverage would agree to such a provision. To date, these provisions have, in at least some cases, seemingly been the cause of significant downward pressure on the post-IPO price of the stock of the companies that have agreed to them because the companies were required to issue significant additional shares in the IPO. Case in point: Tremor Video guaranteed investors $13.997 dollars a share in its IPO but actually went out at $10 a share. In its Registration Statement on Form S-1, Tremor disclosed that “The terms of our Series F preferred stock provide that the ratio at which each share of such series automatically converts into shares of our common stock in connection with the offering will increase if the anticipated initial public offering price is below [the designated price].” Tremor’s stock was down 15% from the IPO price in a single day. (It has since continued to decline presumably due to its failure to meet revenue expectations.) Results such as these happened during a bull market. I can only imagine the results in a bear market. While investors have touted the provision as a significant way to protect themselves – and in one case as the “only” way to protect themselves – these anti-dilution provisions come at a high price and should be considered carefully before entering into a final agreement.
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