DEFINITION of 'Narrow-Based Weighted Average'

Narrow-based weighted average is an anti-dilution provision used to ensure that investors are not penalized when companies are undergoing additional financing or issuing new shares. A narrow-based weighted average takes into account only the total number of outstanding preferred shares for determining the new weighted average price for the old shares.

BREAKING DOWN 'Narrow-Based Weighted Average'

The new weighted average price is adjusted for the preferred shareholder, thus providing protection against dilution. The narrow-based method is the most favorable for investors, as it lowers the price of the preferred shares more than other methods.

Options, warrants and shares that are issuable as part of stock incentive pools are typically excluded from the narrow-based weighted average. For instance, if the company has an employee stock ownership plan, and early employees receive options, those stock equivalents will not be factored into the weighted average.

How the Narrow-Based Weighted Average Diminishes Dilution

The effect of this weighted average is comparable to the broad-based weighted average in that it reduces the conversion price. This reduction is calculated from the ratio of number of shares of common stock that would be issued through a down round at the current conversion price but then compared with the number of shares of common stock issued in the down price at the lower offering. Greater anti-dilution protections are afforded to the investor due to the later shares being more heavily weighted and issued at the lower offering price.

Narrow-based weighted average might be part of the negotiated terms for later funding rounds for a company as more shares are issued and valuations increased. Typical, this is not put into practice in early financing rounds.

The formula for the narrow-based weighted average can be expressed as follows:

Issued price per share for the round x [(Common outstanding pre-deal + Common issuable for amount raised at prior conversion price) √∑ (Common outstanding pre-deal + Common issued in the deal)]

In such an instance, the common outstanding only refers to the preferred shares from the series being adjusted.

The effect of including the additional shares in the broad-based formula reduces the magnitude 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 additional shares issued to holders of preferred stock upon conversion is greater than issued via the broad-based weighted average.

The difference that results from this weighted average is dependent on the relative pricing and size the dilutive financing and the total number of outstanding common and preferred shares.

  1. Broad-Based Weighted Average

    The broad-based weighted average is an anti-dilution provision ...
  2. Weighted Average

    Weighted average is an average in which each observation in the ...
  3. Portfolio Weight

    Portfolio weight is the percentage composition of a particular ...
  4. Weighted Average Market Capitalization

    Weighted average market capitalization refers to a type of stock ...
  5. Fully Diluted Shares

    Fully diluted shares is the total number of shares that would ...
  6. Linearly Weighted Moving Average

    Linearly Weighted Moving Average is a price momentum calculation ...
Related Articles
  1. Investing

    Smart Beta vs. Active Management: Which is Better? (BLK, SCHB)

    Learn how smart beta funds combine the advantages of both active and passive management by tracking customized indexes without capitalization weighting.
  2. Investing

    An Introduction To Sector ETFs

    Find out how sector ETFs can give your portfolio the punch it needs.
  3. Investing

    Billionaire Oprah Makes Bank On Weight Watchers Windfall

    Oprah Winfrey held 10 percent of Weight Watchers shares, but is now taking advantage of the soaring stock prices.
  4. Investing

    Equal Weight Works Across Market Cap Segments

    Equal-weight mid- and small-cap ETFs can generate stellar returns just like their large-cap brethren.
  5. Investing

    VXF: Vanguard Extended Market ETF

    Learn how the Vanguard Extended Market ETF provides investors with exposure to the larger stock universe, except for companies in the S&P 500.
  6. Trading

    Weight Watchers Stock Extends Impressive Rally

    Weight Watchers shares broke out following positive Q4 earnings, but traders will be watching these key levels ahead.
  7. Trading

    Do Adaptive Moving Averages Lead To Better Results?

    These complex indicators can help traders interpret trend changes, but are they too good to be true?
  8. Investing

    Introduction to Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
  1. How do I use Excel to calculate a weighted average?

    Learn about the calculation and interpretation of weighted averages, including how to compute a weighted average using Microsoft ... Read Answer >>
  2. How is the value of the S&P 500 calculated?

    The S&P 500 is a U.S. market index that gives investors an idea of the overall movement in the U.S. equity market. The value ... Read Answer >>
  3. What does the S&P 500 index measure and how is it calculated?

    Learn about what exactly the S&P measures and why it's used by market participants as a tool to understand the broader stock ... Read Answer >>
  4. Do Preferred Shares Offer Companies a Tax Advantage?

    Find out if there is a tax advantage for corporations issuing preferred shares when compared to other forms of financing ... Read Answer >>
Trading Center