We wish to explain the concept “dilution” in the first place in order to better understand the concept “anti-dilution”, which has been translated into Turkish as “seyrelmeme”.
Dilution means a drop in a shareholder’s shareholding ratio in the company due to any reason whatsoever. For instance, if that shareholder does not subscribe to a capital increase or a stock pool is created for the company employees, that shareholder’s shareholding ratio is reduced, that is, “diluted”.
It is commonly seen that the shareholding ratios of existing shareholders fall down in a company if the company attracts new investors during its investment admission period. The action that an investor may take at the time of his investment in order to avoid such an incident in future is that the shareholder may request an anti-dilution right to be agreed in the agreement to work out in his favour.
Thanks to this anti-dilution right, the shareholding ratio of a shareholder in whom this anti-dilution right is vested is kept intact and unchanged even if he does not participate in a capital increase at the valuation in that investment. This anti-dilution right mechanism works as follows in practice: The shareholder maintains his shareholding right intact in the case that the company seeks an investment at a lower valuation in an investment phase subsequent to the ones in which the shareholder has subscribed to the company as that shareholder is allowed to acquire shares from existing shareholders free of charge or at a lower price or to participate in the capital increase at a price lower than the nominal value of the shares or the investment valuation. This way, the shareholding ratio of the shareholder enjoying the anti-dilution right is supported when the shareholder acquires shares at a price lower than their value or participates in the capital increase.
It is particularly noted that investors who make investments in Start-ups, which constantly attract new investments are strongly advised to demand that this right should be defined in their favour.
It is obvious that a shareholder’s shareholding ratio and the dilution rate should be proportionate to the company’s growth rate. This proportionality is secured thanks to this anti-dilution right. This way, an investor holding that right continues to maintain his shareholding ratio in the company’s journey to growth, and try their best so that the company shall attract investment for further growth.
It is critical that one should act during his investment by also taking into account the “exit” option. At this point, there is no dispute that what shareholding ratio a shareholder will have in the case of a valuation is as important as the level of that valuation the company will attain. Owing to anti-dilution right, the gap or deviation is not widened too broad in favour of the investors in a scenario where the shareholder’s shareholding ratio is reduced while the company grows.
There is no dispute that anti-dilution provisions offer an hedge for investors in volatile markets; however, it should be remembered that when such provisions are defined in a shareholders’ agreement, a balance should be struck so that new investors will not feel intimated and existing shareholders will not feel that they are punished.
To sum it up, “anti-dilution” provisions are intended:
- to dispel any doubt or hesitation of investors about the future of their shareholding;
- to help the company attract new investors;
- to ensure that shareholders better embrace the company and try their best to attract investments.
It should be finally noted that an investor willing to invest in a company should not only secure an anti-dilution right for him but also check if existing shareholders enjoy such a right and these rights will be operated in his investment round.