Narrow-Based Weighted Average
What Is a Narrow-Based Weighted Average?
A narrow-based weighted average is a anti-dilution provision used to guarantee that investors are not punished when companies are going through extra financing or giving new shares. It considers just the total number of outstanding preferred shares for determining the new weighted average price for the old shares.
Figuring out a Narrow-Based Weighted Average
Dilution happens when a company issues new stock to raise capital. At the point when the number of shares outstanding increases, each existing stockholder winds up claiming a more modest, or diluted, percentage of the company, making each share less important.
Anti-dilution provisions, for example, a narrow-based weighted average assistance to prevent this from occurring. On the off chance that a company sells more shares at a lower price, the dilution protection provision will make a descending adjustment in the conversion price of the convertible securities. Subsequently, upon conversion, existing investors would receive more shares of the company, consequently permitting them to keep up with their original stake in the company as a percentage of the company's shares.
The narrow-based weighted average may be a part of the negotiated terms for later funding rounds for a venture capital company as additional shares are issued and valuations increase. The intent is to defend the ownership stake that was granted to early shareholders as additional funding rounds stand to additional weaken shares and possibly debilitate their ownership in the company.
Narrow-Based Weighted Average versus Broad-Based Weighted Average
There are two types of weighted average anti-dilution protections: broad-based and narrow-based. Where they contrast is in the types of shares they consider. Broad-based, as its name suggests, is more comprehensive than the narrow-based variant.
A broad-based weighted average accounts for all equity recently issued and at present going through giving. A narrow-based weighted average, then again, just accounts for all convertible preferred shares or common outstanding preferred shares that are convertible for a specific series.
Options, warrants, and shares that are issuable as part of stock incentive pools are regularly excluded from the narrow-based weighted average. For example, in the event that the company has a employee stock ownership plan (ESOP), and early employees received options, those stock equivalents won't be calculated into the weighted average.
The difference that outcomes from this weighted average is dependent on the relative pricing and size of the dilutive financing and the total number of outstanding common and preferred shares.
The impact of remembering the extra shares for the broad-based formula diminishes the greatness of the anti-dilution adjustment given to holders of preferred stock as compared to the narrow-based formula. Through the narrow-based weighted average formula, the number of extra shares issued to holders of preferred stock upon conversion is greater than whatever is issued to holders of preferred stock utilizing the broad-based weighted average formula.
Computing the Narrow-Based Weighted Average
The formula for the narrow-based weighted average can be communicated as follows: Issued price per share for the round x [(Common outstanding pre-deal + Common issuable for amount raised at prior conversion price) \u00f7 (Common outstanding pre-deal + Common issued in the deal)]
In such a case, the common outstanding just alludes to the preferred shares from the series being adjusted.
Benefits and Disadvantages of the Narrow-Based Weighted Average
The narrow-based weighted average is justifiably well known with early investors holding convertible preferred shares. Now and again, certain prospective patrons could even demand that such provisions are incorporated before investing since they are aware that several dilutive funding rounds are probably going to be approaching from now on.
Nonetheless, companies aren't continuously able to offer risk protection on shares. Much of the time, they could decline to grant dilution protection rights to abstain from hampering investor interest in later funding rounds and to increase the chances of encouraging a company's long-term achievement.
Features
- Options, warrants, and shares that are issuable as part of stock incentive pools are commonly excluded from the narrow-based weighted average.
- A narrow-based weighted average is an anti-dilution provision used to guarantee that investors aren't punished when companies issue new shares.
- It considers just the total number of outstanding preferred shares for determining the new, weighted-average price for the old shares.
- The narrow-based weighted average may be part of the negotiated terms for later funding rounds for a company as additional shares are issued and valuations increased.
