Anti-dilution rights are typically granted to venture capital investors in the issuance of preferred stock by emerging high-growth companies. These rights are granted as protection from dilution in the investor’s ownership position arising from the future issuance of new shares, which may occur at a lower price per share than was originally paid by such investor in what is typically referred to as a “down round.” Preferred stock holders are typically not granted any anti-dilution rights solely for the purposes of avoiding percentage dilution, i.e., a reduction in percentage ownership of the company, except to the extent they may be granted pre-emptive rights to purchase additional shares in a future share issuance to avoid being diluted.

Authors: Peter C. Blasier

Occasionally, however, an important potential or existing manager of an emerging company may ask that his or her percentage ownership of stock options be protected against percentage dilution. I am spurred to write this note because I have run across the situation several times recently.

As an example, you might hear something like this from the potential or existing manager: “I know there are going to be at least a couple of rounds of equity financing in the future that will dilute my current share ownership. I need to be assured that my percentage ownership won’t fall below a certain level.” Were this point of view not contrary to traditional venture capital financing theory, it might sound like a reasonable concern from the standpoint of an individual manager, but it almost never makes sense.

Here’s the bottom line: as a general rule, in a high-growth company relying on one or more rounds of future financing, a manager should not be protected from percentage dilution.