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Case study - How anti-dilution clauses affected Redbus

Should you negotiate termsheets and investment documentation? What can the consequences be like if you fail to negotiate? Let’s see what happened in the case study of Redbus (if you have know about the issue before, we suggest you read this to understand precisely how business logic and legal terms apply to a funding transaction). 

At the time of the founder’s exit, Redbus had an enterprise valuation of around Rs. 600 crores (USD 125 million) (Redbus sold out to the Indian arm of the Ibibo group). Do you know what was the shareholding of its two founders Phanindra Sama and Charan Padmaraju? Less than 15 percent. The amount of shares controlled by the founders of Redbus, and consequently the valuation individual shareholders received for their ownership of the company was extremely low in comparison to the amount of funding Redbus had raised. 

Do you know why?
A startup’s valuation in subsequent rounds does not always increase – often it may decrease. This is exactly what happened in the case of Redbus. What happens when the valuation decreases and the startup is raises new investment? In the case of Redbus, the investors who funded the company in its first round had inserted a special clause to prevent their shareholding from being diluted, in the event the company’s valuation was lower in subsequent rounds. This clause is known as a ‘ratchet’. Essentially, if the company’s valuation in a subsequent funding round reduces, the old investor is given additional shares to bring his percentage levels on par. A full-ratchet anti-dilution clause dilutes founders (and any subsequent investors) much more than a weighted average anti-dilution. Redbus had a full-ratchet anti-dilution clause, which was triggered in a subsequent investment as its valuation had reduced. This drastically reduced founder’s shareholding in subsequent rounds.

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