Introduction

Investing in startups during an angel round can be a double-edged sword. One of the key protections that investors seek is antidilution protection, which ensures that they do not lose their equity stake if the company raises funds in a subsequent financing round at a lower valuation. While not all angel investments include such provisions, they are becoming increasingly common, especially in significant rounds.

Overview of Antidilution Protection

Antidilution protection aims to shield investors from the dilution of their equity stake. This protection is particularly important in the dynamic and unpredictable nature of startup financing, where valuation can fluctuate significantly between different investment rounds.

Types of Antidilution Protection

There are two primary types of antidilution protection: full ratchet and weighted average.

Full Ratchet Antidilution Protection

The full ratchet model adjusts the price per share of the investor's original investment to the lowest price at which new shares are sold in subsequent rounds. This means that if a subsequent round offers shares at a lower valuation, the investor's shares will be adjusted to that price. While this is beneficial for the investor, it can significantly dilute the founders' equity stake.

Weighted Average Antidilution Protection

The weighted average approach is more balanced. It takes into account the number of shares issued in the new round and averages the price, thus providing a more equitable solution for both the investor and the founder. This method offers a compromise between full ratchet and no antidilution protection.

Commonality of Antidilution Protection in Angel Rounds

While not all angel investments include antidilution protection, they are more likely to be negotiated in significant rounds or when the startup is perceived to be at a higher risk of needing to raise funds at a lower valuation.

Special Considerations in Angel Investing

Angel investors often invest at earlier stages compared to venture capitalists. Angel money is typically seen as a bridge between the initial seed funding and the later stages of equity financing. Despite this, they often demand the same level of protection as venture capitalists. This is because angel investors also bear significant risk and believe they should be treated fairly.

It's important to note that convertible notes are a common financial instrument used by angel investors. Convertible notes provide a way for angel investors to invest without immediately needing to set a valuation. However, the terms of these notes, including antidilution protection, are still subject to negotiation.

Conclusion

In conclusion, antidilution protection is becoming more common in angel equity rounds, especially in significant rounds or high-risk situations. The two primary types of protection, full ratchet and weighted average, serve to balance the interests of both investors and founders. While not all angel investments include these provisions, they are standard unless the angel investment is truly indistinguishable from co-founder equity at lower valuations.

Disclaimer

This article is intended for informational purposes only and should not be construed as legal advice. Readers should consult with their own legal counsel for specific guidance on legal matters.