Dilutive Financing
A dilutive financing is a sale of equity at a price lower than the previous valuation of the company. Sometimes this happens because the company lost value and must raise money at a decreased valuation. Other times, this can be motivated to dilute a shareholder’s interest.
In dilutive financings, courts have looked at:
- Whether there was a need for the financing
- Whether this was an “inside down round” meaning that the directors or majority shareholders stood to gain from the round by the dilutive effect or their own participation in the equity purchase
A financing or stock issue can be unfairly dilutive even without a valuation of the company.
These transactions and others may also be reviewed for the decision of the Board of Directors. Typically, courts afford a good deal of discretion to corporate directors and officers, which is referred to doctrinally as the Business Judgment Rule. However, if the minority shareholder plaintiff can show satisfactorily to the court that something is amiss and/or that there were conflicts of interest by the directors, the court will scrutinize the transaction and the directors will have to prove "entire fairness," which requires a showing that the minority shareholders received a fair price and were treated fairly procedurally.
