Due to the pandemic, times are challenging for some business owners. Temporary closing on businesses, enforcement of Force Majeure in contracts and delay in payments have caused major setbacks and, in many instances,, crippled businesses. Companies need positive cash flow to stay afloat and continue to live to fight another day. For companies that adopt sustainable assets and business models, it is time for capital raising to save the business and allow it to live by way of new investments and in some cases, existing shareholders to provide new capital funding. In this write up, I will help you to explore the different perspectives on Non-Dilution or Anti-Dilution clause – normally found in Shareholders Agreement or Shares Subscription Agreement.
What is Non-Dilution or Anti-Dilution clause?
Share dilution is a reduction in a shareholder’s percentage of shareholding in the Company, which only caused by an increase in the total number of issued shares in the Company. Thus, Non-Dilution is a clause that normally restricts all of the shareholders or the Company in reducing their shareholding percentage in the Company. Imagine that shareholding of the Company as a pie and each shareholder represents a small cut of the pie. The Non-Dilution would stop each slice from getting cut smaller as more people want the same pie.
Non-Dilution for the Company
At one point, the Company would not be benefiting the most from non-dilution. The Company will not be able to accept new shareholders and together with outside money to run its business. In situations where cash flow and operation require urgent new investments or in the case for start-up companies, it will be difficult to get each of the existing shareholders to waive such protection. Without positive cash flow and capital for business development, shareholders are risking their interests and future profits from the Company.
From another angle, by having non-dilution clause, it would secure the Company’s relationship and interest with the shareholders for long run. The shareholders may be committed to stay and willing to dive into the Company’s business venture without any interference from new third-party. However, in doing this, the shareholders and Company should also consider supplementing the non-dilution clause with obligations to provide shareholders loan, whenever it is needed or called by the Company. However, please be cautious on tax implications for the shareholders loan and interest payable by the Company.
Non-Dilution for Shareholders
Non-Dilution should be a shield or protection for the investors or shareholders in respect of their investments in the Company. For founding members/shareholders, non-dilution provides them with security on control over the Company’s day to day affairs. It works best for start-up for their founders to have control as knowledge, ideas and technical know-how are developed and orignated from the founding members/shareholders. In a well-established and profitable business, non-dilution may be seen as protection for the shareholders to enjoy better percentage of returns/profits from the Company. However, it is important for the shareholders to keep in mind:-
“Better to have smaller cut of the Company that is making profit and highly valued rather than bigger portion of the Company that is at loss and failing”
As dilution of shareholding structure may adversely affect the control of the Company’s day to day affairs as well as percentage of returns/profits from the Company, the shareholders and Company that is planning to issue shares to the employee through ESOS scheme as alternative to full-pay salary might find themselves stuck whenever the employee
Protection from Risks Attached to Non-Dilution
There are ways for shareholders to continue maintaining control over the Company’s affairs despite dilution of their shareholding. But, it would require negotiation and other form of protections such as Pre-Emption Rights, Put-Option Rights and Tag-Along Rights to be inserted in the formal legal documents between shareholders. Others would include limitation on the appointment of directors and executives of the Company by the shareholders.
Surely, desperate time calls for desperate measures. But kindly seek for appropriate advice from your lawyers on ways work best to secure your interest. Look before you leap!
Nazmi Mohd Zaini is the Partner of Nazmi Zaini Chambers. He has experience in fund raising activities and general corporate transactions including subscription of shares and ESOS scheme for start ups.