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posted 2 years ago

In our previous article, we identified the various stages commonly adopted by Startups in raising funds. Each funding round would typically involve the issuance of shares by the Startup to investors for an injection of funds into the business. The implication of issuing fresh shares at every investment round is a possible dilution of the value of shares held by the founders and existing investors in the business.

In this article, we have set out below the mechanism that can be adopted to protect against excessive dilution.

How are shares granted to investors under Nigerian law? Under Nigerian law, shares can be granted to investors after a funding round through any of the following routes: (i) where shares have been fully allotted, either by a transfer of a portion of the shares currently held by shareholders to the investors; or by increasing the share capital and issuing fresh shares to the investors; (ii) where the share capital has not been fully allotted, by allotting the available portion to the investors; or by subdividing the share capital, increasing the number of shares in issue and decreasing the nominal value of the shares.

How does dilution occur? When shares are issued to new investors, the percentage of an existing investor or founder’s stake/shareholding in the Startup may decrease and in such an instance, a dilution of shares would be said to have occurred.

A practical example is as follows: Assuming an investor (“Investor A”) owns 100,000 shares in a Startup having 1,000,000 shares outstanding (i.e., shares held by existing shareholders) at $2 price per share, meaning Investor A has a $200,000 stake in the Startup valued at $2,000,000. He would therefore own 10% of the Startup. Where the Startup subsequently engages in a financing round and issues an additional 1,000,000 shares bringing the total outstanding shares to 2,000,000, at the same $2 value per share, Investor A would then hold a $200,000 stake in a $4,000,000 Startup and therefore his shareholding in the Startup would have been diluted to 5%.

Does Dilution reduce the value of shares held? A reduction in the percentage of shares held by an investor or founder in a Startup does not necessarily mean a reduction in the monetary value of the shares held by that investor. As a fresh injection of capital in the business may result in an increase in the valuation of the business and, therefore, an increase in the value of each share held in the business (e.g., 1 share previously worth $1 might be worth $5).

It is, however, possible for the business to be valued for less in new investment rounds so that new investors get more shares for less (“Down Round”), thereby diluting the value of shares held by existing investors.

How does dilution affect voting rights? An issue with dilution of shares is the effect it has on voting rights and controlling interests in the business (particularly for the founders). Under Nigerian company law, certain decisions require a special resolution, such as change of name, an alteration of the memorandum and articles of association, etc. must be by a special resolution passed by not less than 75% votes. Whilst decisions such as the removal of directors and appointment of auditors require at least 51% votes to be passed. Founders would typically want to maintain a sufficient number of shares in the business to enable them make key decisions for the business.

Are there provisions under Nigerian law to prevent involuntary dilution of shares? Under Nigerian company law, there are provisions that require founders to first offer their shares in the Startup to existing shareholders prior to offering such shares to new investors (this is, however subject to the Articles of Association and shareholders’ agreement). This ensures that the existing shareholders are made aware of subsequent funding rounds and can opt to invest in the business to protect their interests.

How can investors or founders contractually protect against dilution? Anti-dilution provisions are clauses included in an investment agreement or a financing document to protect founders and investors from the effect of dilution, particularly if shares are sold at a lower price during subsequent funding rounds. These provisions are capable of mitigating the effect of dilution on an existing investor or shareholder.

What are the types of Anti-dilution provisions?

There are various types of anti-dilution provisions typically included in investment agreements, some of which are discussed below.

   1. Full Ratchet Provision

A full ratchet provision allows an existing investor to adjust the value of his shares purchased to the share price being offered to new investors at subsequent Down Rounds. Consequently, the existing investor may become entitled to additional shares and retain his ownership percentage in the Startup at no cost.

Using our example above, in the subsequent round of investment, let’s assume the shares being offered to new investors were offered at a lower price of $1 per share, (“Conversion Price”), where a full ratchet provision was included in Investor A’s investment agreement, his percentage holding in the Startup will not be diluted in the new round and rather than holding 100,000 shares, he would hold 200,000 shares in the Startup.

   2. Weighted Average Provision

A weighted average provision allows an existing investor to adjust the value of his shares based on a formula stated in the agreement. A narrow based weighted average formula or a broad based weighted average formula may be adopted.  The broad based formula takes into account all shares previously issued by the Startup whilst the narrow based formula is limited to preferred or common shares issued.

When a weighted average formula is adopted, the existing investor would not be entitled to retain 100% of his ownership percentage in the Startup like the Full Ratchet provision above, rather the investor would be entitled to adjust his percentage holding in the Startup upwards to a percentage considered fair for both existing and new investors.

This anti-dilution provision is more common in practice because it is the compromise provision for all parties involved.


Founders and investors should, however, be mindful of anti-dilution provisions as such provisions can give investors controlling rights in the Startup for a long period of time. Such long-term controlling rights may be a hurdle to future funding rounds and may also not align with the growth plan of the business. A way to mitigate the effect of an anti-dilution provision is by limiting its operation to a particular period or funding round. In addition, Startups should always ensure that they engage experts before signing investment agreements so as not to create future problems for the company.


[1] Dollar examples are only for explanatory purposes.


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