Protection mechanisms for investors

Dilution protection

How much investors are paid out depends first and foremost on the number of digital company shares they own. The more shares an investor buys, the higher the payout. The payout may decrease if the company issues more shares to other investors, as this reduces the percentage of total shares issued per investor. This corresponds to a dilution, which also occurs in classic financing rounds. As a rule, this dilution is only accepted by investors if the valuation increases and the value of the investor's participation remains at least stable.

For example, let's assume a company with a registered share capital of EUR 50,000. In addition, there are 10,000 digital shares in a company that can be purchased by investors with the value of one Euro of the registered share capital.

There are two investors (Investor A and Investor B) where Investor B buys a Digital Company Shares at a lower price than Investor A:

  1. Investor A buys 1,000 Digital Company Shares at a price of EUR 500. His share is then 1,000/(1,000 + 50,000) = 1/51 and the value of the company after the sale of the Digital Company Shares is EUR 500,000 / (1/51) = EUR 25,500,000.

  2. Investor B buys an additional 1,000 Digital Company Shares at a price of EUR 100 per unit. This is an investment of EUR 100,000 and a post-money valuation of EUR 100,000/(1,000 / (1,000 + 51,000)) = EUR 5,200,000.

  3. As a result of this implicit revaluation of the company, the value of the digital shareholding owned by Investor A is then 1/52 * EUR 5,200,000 = EUR 100,000. Significantly less than the original purchase price of EUR 500,000.

This scheme provides a guarantee of a minimum valuation which the company intends to achieve by selling the Digital Company Shares. This protective measure is an important purchase argument for potential investors.

Down round protection

Rules to protect investors from down rounds are all based on the idea that if a company sells parts of its share capital for a price below a certain threshold, existing investors will be compensated with new additional shares. This scheme is very common in venture capital financing. For owners of Digital Company Shares, this would mean that they receive more units without actually paying for them. Since the creation of new units can lead to complex scenarios in secondary markets, we have opted for a different approach:

Instead of creating more units of the Digital Company Shares, the issuer has a duty to adjust the calculation factor, which is securely stored in the blockchain. The Calculation Factor determines how much of a digital equity investment economically corresponds to one euro of the share capital. So instead of compensating a Digital Company Share holder with more shares, the issuer reduces the calculation factor, resulting in a higher value per unit of the Digital Company Shares.

Example:

  1. The company has a share capital of EUR 50,000. In addition, there are 1,000,000 Digital Company Shares that can be purchased by investors. The calculation factor is 100 at this time, i.e. 100 Digital Company Shares correspond to one euro of the share capital. This in turn means that the Digital Company Shares have a value of EUR 10,000 of the share capital.

  2. Let us assume that the company has already sold all Digital Company Shares to investors at a price of EUR 5.00 each. The price related to one euro of the share capital was then EUR 5.00 100 = EUR 500 and the company has a post-money valuation of EUR 500 * (50,000 + 10,000) = EUR 30,000,000. The total value of the Digital Company Shares is now EUR 500 * 10,000 = EUR 5,000,000.

  3. Now the company makes a financing round via the commercial register and creates new share capital of EUR 10,000 and sells it at a price of EUR 100 per euro of share capital. This results in a post-money valuation of EUR 100 * (10,000 + 10,000 + 50,000) = EUR 7,000,000. This means that the value of the digital shareholding has been diluted as the total value is now only EUR 100 * 10,000 = EUR 1,000,000.

In order to protect investors of the Digital Company Shares from such a dilution, the issuer sets a minimum price for new capital increases at the outset. If their new share capital sells below this minimum price, the investors of the Digital Company Shares are compensated. Let's look at the example above with the protection mechanism and a minimum price of EUR 200:

  1. We calculate a new guaranteed price per euro of share capital using the weighted average. We meet in the middle between the actual price of the new round and the minimum price weighted with the amount of the issued share capital: ((10.000 * 200 EUR) +(10.000 * 100 EUR))/(10.000 + 10.000) = (2.000.000 + 1.000.000) / 20.000 = EUR 150,00.

  2. It is therefore the obligation of the issuer to ensure that the value of the issued Digital Company Shares is EUR 150.00 per share. However, the price after the round is only EUR 100. To adjust the value, update the Calculation Factor to 100 * EUR 100/ EUR 150 = 66,67.

  3. The 1,000,000 issued Digital Company Shares then correspond to 1,000,000 pieces / 66.67 pieces / EUR = EUR 15,000 of the share capital. The total value of the Digital Company Shares now amounts to EUR 100 * 15,000 = EUR 1,500,000.

The higher you set this threshold, the more you have to compensate the owners of the Digital Company Shares. With a Down-Round-Protection-Price of EUR 300 for example the guaranteed price ((10.000 * 300 EUR) +(10.000 * 100 EUR))/(10.000 + 10.000) = (3.000.000 + 1.000.000) / 20.000 = EUR 200,00 and the Calculation Factor would even have decreased to 100 pieces / EU * (EUR 100 / EUR 200) = 50 pieces / EUR.