Adjustment clause in case of capital increase with preemptive rights

‍

1. Context

A company(X) issues new shares to raise funds for a project.
To protect existing shareholders from dilution, the law requires the detachment of a preemptive subscription right attached to existing shares. This right is represented by a tradable instrument — the preemptive subscription right (PSR) — which shareholders can either exercise or sell on the market.

If company X has already issued convertible bonds or warrants (BSA), and the new capital increase is made at a price lower than what the holders paid when exercising their conversion or subscription rights, they must not be penalized.

The adjustment involves modifying the conversion ratio — i.e., the number of shares received per bond — to reflect the new share value.

‍

2. Mechanism of the adjustment clause

The purpose of the adjustment clause is to revise the conversion price (or the number of shares) of the convertible instrument held by the investor. The goals to ensure that, after conversion, the investor receives a number of shares that preserves the economic value of their initial investment.

There are two main methods for calculating this adjustment:

a) Full ratchet method

This is the most protective method for the investor.

• Principle: the investor’s conversion price is simply replaced by the new issue price.
• Consequence: the investor can convert their securities at the lowest price the company has ever issued shares, resulting in a significantly higher number of shares.

Example :

• The investor holds a convertible bond with a conversion price of €10.
• The company issues new shares at €5. ‍
• Adjustment: the conversion price is revised to €5.
• For a €10,000 investment, the investor receives 2,000 shares (€10,000 / €5)
  ‍

‍b)Weighted average method

This is a more balanced method, commonly used and generally better accepted by founders.

• Principle: The new conversion price is calculated based on a weighted average between the old price and the new issue price, taking into account the number of shares issued.

‍Formula:
New Price = (Old price×shares outstanding before the increase)+(New issue price×number of new shares)÷Total Shares after the increase

‍Example:

• Shares outstanding before increase: 1,000
• Old conversion price: €10
• New issuance: 500 shares at €5
• Calculation: (€10×1,000)+(€5×500)/(1,000+500)=(€10,000+€2,500)/1,500=€8.33
• Adjustment: conversion price is revised to €8.33
• For a €10,000 investment, the investor receives approximately 1,200 shares (€10,000 / €8.33) instead of the initial 1,000.

‍

Conclusion

This clause is essential to balance the relationship between issuers and investors, ensuring that investors are not penalized by future fundraising rounds necessary for the company’s growth.

‍