Anti-Dilution Provisions

Anti-dilution provisions are the preferred-stock rights that adjust a series' conversion price downward if the company later issues stock at a lower price. They protect investors from being economically diluted by down rounds, with two main structural flavors: weighted-average (founder-friendly) and full-ratchet (punitive). It is one of the most economically significant terms in the preferred stock package, and the choice between flavors materially affects founder and common-holder outcomes when the company has to raise at a lower price.

The two structural flavors:

• Broad-based weighted-average (modern standard, founder-friendly): the conversion price adjusts based on a formula that weights the size of the down-round dilution against the total cap table. The formula: NCP = OCP x ((A + B) / (A + C)) where NCP = new conversion price, OCP = old conversion price, A = shares outstanding before down round (broad-based: including options, warrants, convertibles), B = consideration received divided by OCP (shares that would have been issued at old price), and C = actual shares issued in down round. The adjustment is partial; preferred gets some protection but common still bears most of the dilution.
• Narrow-based weighted-average: similar formula but A only includes outstanding common and preferred (not options/warrants/convertibles), producing a slightly larger adjustment.
• Full-ratchet (investor-friendly, increasingly rare except in distressed situations): the conversion price simply resets to the new (lower) price, regardless of round size. A 1-share down round at a 50% lower price ratchets ALL prior preferred to that 50% lower price. The economic effect: massive dilution of common stock and the founder team for a small amount of new capital.

Concrete example: company raised Series A at $10/share with 10M shares outstanding. Three years later, they raise a Series B at $5/share, issuing 2M new shares.

• Broad-based weighted-average: Series A conversion price adjusts from $10 to approximately $8.75 (modest founder dilution).
• Full-ratchet: Series A conversion price adjusts from $10 to $5 (doubling the Series A's effective ownership). Founder ownership cuts roughly in half.

Standard exclusions (carve-outs): most anti-dilution provisions exclude option pool issuances to employees, shares issued in M&A, shares issued for strategic partnerships, shares issued upon conversion of existing convertibles, and shares issued under existing warrants. Pay-to-play: some anti-dilution provisions include pay-to-play language requiring preferred holders to participate in the down round to maintain their anti-dilution protection, creating pressure on existing investors to follow on.

Ryan's Take

Anti-dilution is the preferred provision that does its real work when things go badly. In a flat or up environment, it doesn't activate. In a down round, it determines whether the founder team gets diluted modestly (broad-based weighted-average) or savaged (full-ratchet). The right discipline at term sheet time: insist on broad-based weighted-average, push for the standard carve-outs (option pool, M&A, partnerships), and resist any narrowing of the carve-outs. Full-ratchet is the term you walk away from unless you're in a distressed financing where it's the price of survival. Even then, model out what it actually does to your ownership before you sign. The math is uglier than the term sheet language suggests.

What founders get wrong: Accepting full-ratchet because they're confident they'll never raise a down round. Most founders who eventually take a down round were confident at the prior round that they wouldn't. The point of anti-dilution provisions is to govern the scenarios you're hoping to avoid; the worst time to discover you accepted full-ratchet is when the down round closes and you watch your ownership get cut in half for a small bridge of capital. Negotiate for broad-based weighted-average at every priced round; the modest cost (a tougher conversation at the term sheet) is dwarfed by the protection if the worst case shows up.

Related: [Preferred Stock] · [Weighted-Average Anti-Dilution] · [Full-Ratchet Anti-Dilution] · [Broad-Based Weighted-Average] · [Down Round]

FAQ

What are anti-dilution provisions? Contractual rights attached to preferred stock that adjust the conversion price downward (resulting in more common shares per preferred upon conversion) if the company later issues stock at a price lower than what the preferred holder paid. Protects investors from economic dilution in down rounds.

What's the difference between weighted-average and full-ratchet? Weighted-average produces a partial adjustment based on the size of the down round relative to the total cap table (founder-friendly). Full-ratchet resets the conversion price all the way to the new (lower) price regardless of round size (investor-friendly, punitive to common).

Is anti-dilution standard in venture rounds? Yes. Almost every priced venture round includes anti-dilution provisions on the preferred. The modern standard is broad-based weighted-average with carve-outs for option pool, M&A, partnerships, and pre-existing convertibles. Full-ratchet appears in down rounds, distressed financings, and aggressive structured deals; founders should resist it.