Assignment 3 (Anti-dilution protection) (7 points)

The founders of a start-up issued themselves 1,000,000 shares of common stock when the company was formed. One year later, a venture investor provided $500,000 in return for preferred stock shares convertible into 500,000 shares of common stock ($1.00 per share).The venture investor negotiated FULL RATCHET anti-dilution protection at the time of the $500,000 investment.Subsequently the company needed to raise $625,000 and did so by issuing 1,000,000 new shares of convertible preferred stock ($.625 per share).

Initial conversion price is $1/share

Company sells 1,000,000 new shares at $.625

How many shares are considered "outstanding" after Round 2 (considering the revised full ratchet conversion price)? (2)

What are the percentage ownership interests of the Founders, Round 1 and Round 2 investors after the $625,000 Round 2 investment (based on the Round 1 investors FULL-RATCHET anti-dilution protection)? (1)

If the Round 1 investors have weighted average anti-dilution protection, what is the new conversion price for the Round 1 investors after the $625,000 Round 2 investment (down from $1.00)? (2)

What are the percentage ownership interests of the Founders, Round 1 and Round 2 investors after the $625,000 Round 2 investment, if Round 1 investors have weighted average anti-dilution protection? (1)

Explain the role anti-dilution protection plays in raising capital.Discuss the risk factors which it addresses; whether investors want to take advantage of anti-dilution protection; AND identify a situation in which anti-dilution protection does not affect conversion price or ownership interests. (Think about this.Answers are almost self-evident) (1)