What Is a Broad-Based Weighted Average?
The broad-based weighted average is an anti-dilution provision used for the benefit of existing preferred shareholders when additional offerings are made by the corporation. The broad-based weighted average accounts for all equity previously issued and currently undergoing issue. At the time of the secondary offering, the company will adjust the value of the preferred shares to a new weighted average price using the broad-based weighted average calculation.
- A broad-based weighted average is a provision that protects existing preferred shareholders from the dangers of share dilution that occurs when a company issues new shares.
- The value of preferred shares will be adjusted to a new weighted average price using the broad-based weighted average calculation.
- The calculation accounts for all equity previously issued and currently undergoing issuing, including convertible securities such as options and warrants.
- Early shareholders in a company may require a broad-based weighted average provision before investing in order to safeguard their ownership stake should the company seek additional rounds of funding.
Understanding a Broad-Based Weighted Average
In order to raise additional capital, a company's board of directors may decide to issue new shares to sell on the public market. This is known as a seasoned equity offering or a seasoned issue. Management might use the funds to pay down debt or to embark on a new project, such as building a factory or starting a new product line. From management's perspective, the goal is to improve the company's profitability and the value of the stock.
From an existing shareholders' perspective, however, the sale of new shares can be seen in a negative light as it can lead to dilution of their current stake in the company. As the number of the company's shares increases, existing shareholders are then left owning a smaller percentage of the company and each share they own will be less valuable.
A broad-based weighted average, which is a provision given to shareholders of a company's preferred stock, provides investors with anti-dilution protection. When a company issues new shares, the value of the preferred shares will be adjusted to a new weighted average price using a calculation intended to protect investors from the dangers of share dilution.
Calculating a Broad-Based Weighted Average
Calculating the broad-based weighted average uses a formula that takes into account the price per share, the amount of money a company previously raised, the amount of money to be raised in the new stock issue, and the price per share under that deal.
The formula for a broad-based weighted average is:
(Common outstanding previously issued + common issuable for the amount raised at the prior conversion price) ÷ (Common outstanding previously issued + common issued in the new deal).
For the broad-based weighted average, the representation of common outstanding includes all common and preferred shares on an as-converted basis, as well as all outstanding convertible securities, such as options and warrants.
Broad-Based Weighted Average vs. Narrow-Based Weighted Average
A narrow-based weighted average is another approach to protect shareholders from share dilution. This anti-dilution provision takes into account only the total number of outstanding preferred shares when calculating the new weighted average price for existing shares. A narrow-based weighted average excludes options, warrants, and shares that are issuable as part of stock incentive pools.
In contrast, a broad-based weighted average accounts for all equity previously issued and currently undergoing issuing, including convertible securities such as options and warrants. Including these shares means the magnitude of the anti-dilution adjustment given to preferred shareholders is reduced compared to the narrow-based weighted average formula. With the broad-based weighted average formula, holders of preferred stock will receive fewer additional shares upon conversion than what would be issued using the narrow-based weighted average formula.
Benefits of a Broad-Based Weighted Average
The broad-based weighted average often comes into play with successive venture capital financing rounds as more shareholders invest in the company. The intent is to safeguard the ownership stake that was granted to early shareholders as more funding rounds stand to further dilute shares and potentially weaken their interest ownership in the company. This can be a particular issue if the company sees a “down round” where it is devalued and the shares they hold likewise lose value.
Dilution may be inevitable as a company grows and gains more shareholders. The early backers may require dilution protection provisions when they invest to shield their interests as the company evolves. This can also protect them against intentional dilution that is purposely meant to weaken their ownership positions with the company.
There are variations in this calculation that quantify common outstanding shares differently. For instance, common outstanding could represent just the preferred and common stock that is outstanding, but not convertible securities such as warrants and options, or the common shares issuable upon the exercise of debt.