Broad-Based Weighted Average: Explanation, Function, and Real-World Example

What Is a Broad-Based Weighted Average?

A broad-based weighted average is a provision that protects preferred shareholders from losing value when a company issues more stock. It calculates adjustments using all existing shares and convertible securities to reduce dilution. This rule is important when companies issue new stock, and it differs from narrow-based weighted averages, which we also explain below.

How Broad-Based Weighted Averages Protect Shareholder Interests

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 called a seasoned equity offering, or 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.

Existing shareholders might view new share sales negatively since it can dilute their stake. 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.

The Formula for 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.

Comparing Broad-Based vs. Narrow-Based Weighted Averages

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 from 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 anti-dilution adjustment for preferred shareholders is less than with a narrow-based weighted average. 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.

Key Advantages of Using a Broad-Based Weighted Average

Broad-based weighted averages are often used during venture capital rounds as more investors join. 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 is especially true in a “down round” where the company loses value, causing shares to also drop in 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.

Variations in the calculation may measure common 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.