Anti-dilution provisions protect investors from dilution in a down round. The three types are full ratchet (most investor-friendly), narrow-based weighted average, and broad-based weighted average (most founder-friendly and market standard).
What Is Anti-Dilution Protection?
When a company raises at a lower valuation than the previous round (a "down round"), anti-dilution provisions protect investors by adjusting their conversion price downward, giving them more shares.
The Three Types
1. Full Ratchet (Most Investor-Friendly)
Conversion price adjusts to the price of the new round, regardless of how many shares are issued.
Example: Series A at $1.00/share. Down round at $0.50/share → Series A conversion price adjusts to $0.50 (investor gets 2x shares)
Impact: Extremely dilutive to founders. Rarely seen in modern venture financing.
2. Narrow-Based Weighted Average
Conversion price adjusted based on weighted average of old and new prices, using only preferred shares in the calculation.
3. Broad-Based Weighted Average (Market Standard)
Same as narrow-based, but uses ALL shares outstanding (common + preferred + options + warrants). Produces a smaller adjustment — more founder-friendly.
This is the market standard. Push back on any other form.
Pay-to-Play Provisions
Require existing investors to participate in a down round to maintain anti-dilution protection. Investors who don't participate lose their anti-dilution rights. Founder-friendly — ensures investors who don't support the company don't benefit from anti-dilution.
Key Takeaways
- Anti-dilution provisions protect investors in down rounds by adjusting their conversion price.
- Broad-based weighted average is the market standard — push back on full ratchet.
- Full ratchet is extremely dilutive to founders and is rarely seen in modern venture financing.
- Pay-to-play provisions require investors to participate in down rounds to maintain anti-dilution rights.
- Model the impact of anti-dilution provisions before signing a term sheet.
Filed under M&A, Partnering & Due Diligence. Working session: Calendly.
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