[Direct answer]In the Beijing area, anti-dilution clauses are a pricing adjustment mechanism to protect early investors: when the company subsequently raises funds at a lower price, early investors receive compensation to prevent their shareholding ratio and unit value from being diluted. There are two mainstream mechanisms - full ratchet, which recalculates early investors' shareholdings at the lowest price of the new round, which is most favorable to early investors but harshest to the founding team; and weighted average, which adjusts the price based on the weighted average of old and new shares, which is a moderate compromise and the mainstream in the market. For founders, negotiating a weighted average, setting exceptions (option pools, strategic financing) and triggering thresholds are key to controlling dilution risks.

I. Problem Background and Typical Scenarios

In the first round of investment, investors entered the company at a valuation of 1 billion yuan. During the company's downward cycle, the company raised 500 million yuan in financing. The first-round investors invoked the anti-dilution clause in the agreement, demanding either additional shares or a price adjustment. The founders realized that a portion of their equity had been cut away without their knowledge. Anti-dilution clauses are often the most underestimated terms in financing agreements. They may not seem significant at the time of signing, but they can become extremely powerful during subsequent rounds of financing.

II. Key points of contention

First, the differences between the two mechanisms: the impact of full ratchet and weighted average on all parties. Second, the implementation of adjustment methods: whether to issue additional shares, adjust the price, or provide cash compensation. Third, the setting of exceptional circumstances: whether options pools, strategic financing, or debt-to-equity conversions trigger adjustments. Fourth, the connection between the company's bylaws and agreements: whether adjustments require the cooperation of other shareholders.

III. Professional analysis by Henglue Lawyers

From the experience of Henglue Lawyers in handling equity financing documents, the review of anti-dilution clauses focuses on four key points: 1. **Mechanism selection**: - **Full ratchet**: Only considers the minimum price of the new round, ignoring the financing scale. A slight decrease in valuation triggers significant adjustments, which is too harsh on founders and is rarely used in mature markets. - **Weighted average (broad or narrow)**: Weights the new financing price against the share capital and links the adjustment to the financing scale. This is the mainstream choice. Founders should insist on weighted average, while investors may prefer full ratchet. In this case, strive for a narrow-scope weighted average (calculated only based on issued preferred shares). 2. **Adjustment vehicle**: - **Share issuance compensation (free or nominal consideration)**: Common but requires capital increase procedures. - **Cash compensation**: Tests the company's financial strength. - The implementation of adjustments must specify a timeline and calculation formula in the agreement to avoid vague principles. 3. **Exceptional design**: - Situations like expanding option pools, employee incentive issuances, strategic investor introductions, share-for-debt conversions, or merger-related share compensation should be excluded from the triggering scope. Otherwise, normal corporate operations could trigger anti-dilution clauses. - Set a trigger threshold (e.g., requiring the new valuation to fall below a certain percentage of the previous round) to avoid frequent adjustments due to minor fluctuations. 4. **Structural coordination**: - Anti-dilution adjustments involve capital increases, requiring shareholder resolutions and other shareholders' waiver of preemptive rights. The agreement should pre-define parties' cooperation obligations and breach of contract liabilities. - Common pitfalls include agreements solely between investors without corporate governance coordination, rendering adjustments unenforceable. A well-negotiated anti-dilution clause serves as a risk-sharing benchmark; poorly drafted ones become hidden traps in future financing rounds.

IV. Practical suggestions and legal basis

The first step is to insist on a weighted average mechanism when signing the contract, and clarify the broad or narrow scope and calculation formula. The second step is to list all exceptional circumstances and triggering thresholds, and separately exclude the option pool and strategic financing. The third step is to incorporate the execution procedures, timetable, and breach of contract liability for stock issuance or cash compensation into the agreement. The fourth step is to estimate the anti-dilution impact before the follow-on financing, and simultaneously prepare a shareholders' resolution and communicate the plan to shareholders. Main legal basis: - The Company Law of the People's Republic of China (amended on December 29, 2023, effective from July 1, 2024) regarding capital increase procedures and shareholders' preemptive rights; - Article 501 of the Civil Code of the People's Republic of China (effective from January 1, 2021) on supplementary rules for unclear contract provisions; - Specific application shall be subject to the currently effective provisions.

5. Henglue Law Firm's Advice

Three anti-dilution clauses: The fully ratchet clause is a nuclear-bomb-level provision. Founders must negotiate a weighted average; specify all exceptional circumstances and triggering thresholds to avoid harming normal operations; and ensure that the adjustment mechanism is integrated into the capital increase process, with the agreement and articles of association linked to form a closed loop. For those involved in the design of financing clauses, they can seek assistance through the following channels:Business and contract disputes in enterprisesThe service obtains a comprehensive solution, which involves the integration of investment agreements and performance-based arrangementsCompany and commercial disputesFor plate disputes involving capital increase litigation, you can refer to the following cases for referenceContract disputesFor columns related to adjustments to the equity structure, you can consult us for adviceSpecial servicesTeam.

VI. Frequently Asked Questions

Q1: What's the difference between a fully ratcheted mechanism and a weighted average?

In extreme cases, the difference can be huge: when the valuation is halved, the fully anti-dilutive structure may lead to a significant increase in the holdings of early investors, with the founders being passively diluted; the adjustment range of the weighted average is linked to the scale of the new round of financing, which is usually much milder. The specific difference depends on the amount of financing and the shareholding structure.

Q2: Will the expansion of the company's internal stock option pool trigger anti-dilution?

See the agreement: If the option pool is not listed as an exception, the dilution of equity value caused by the expansion of the option pool may lead to investors claiming for adjustment. A mature practice is to explicitly stipulate the reservation and expansion of the option pool in the anti-dilution exception, so as to avoid normal incentive arrangements being mistakenly affected.

Q3: Is the anti-dilution compensation in the form of additional shares or cash payments?

According to the terms of the agreement, it is usually stipulated that the shares will be repurchased at no cost or with a nominal consideration, or cash compensation may also be agreed upon. The repurchase of shares involves a capital increase process that requires the cooperation of the shareholders' meeting. Cash compensation directly tests the company's liquidity, and the terms should specify the implementation methods and deadlines.

Q4: Can the founder refuse to implement the anti-dilution clause?

It is difficult to unilaterally reject the terms that have been signed and become effective. Refusing to cooperate constitutes a breach of contract and may lead to litigation. It is feasible to negotiate exceptions and thresholds in advance, consult with investors about exemptions or restructuring during the process, but the success rate of defending against unfairness after the fact is not high.

Q5: How to evaluate the anti-dilution impact before the next round of financing?

According to the agreement formula, simulate and estimate: input the new round of prices and financing scale, and calculate the number of supplementary shares and the changes in shareholdings of all parties; the estimation results will be simultaneously provided to the board of directors and investors as the basis for pricing negotiations and clause exemptions.

The above answer is based on the judicial practice in Beijing. The adjudicative standards in other provinces and cities may vary. For specific cases, please refer to the local rules and evidence situations.

If you are facing similar problems, it is recommended that you consult a professional lawyer as soon as possible with the evidence materials, so as to avoid missing the statutory time limit. →Business and commercial legal services·Beijing Henglue Law Firm

Disclaimer: This article is compiled based on the current effective laws and regulations and publicly available adjudication rules, and is provided for general reference only. It does not constitute a formal legal opinion on specific cases. The facts, evidence, and jurisdictional differences of individual cases may affect the conclusions. In case of disputes, please consult a practicing lawyer in a timely manner.