Anti-Dilution Provisions
Quick Facts
- Purpose: Protects investors from price decreases in future funding rounds
- Types: Full ratchet (aggressive) vs. weighted average (standard)
- Where found: Preferred stock terms, typically in Series A and later
- Who benefits: Investors (at the expense of founders and common shareholders)
Anti-dilution provisions protect investors from the dilutive effect of a "down round"—when a company raises money at a lower valuation than previous rounds. These provisions adjust the conversion price of preferred stock, giving protected investors more shares to compensate for the valuation drop.
In Plain English
Imagine you invested $1 million at $10 per share, getting 100,000 shares. Then the company struggles and raises at $5 per share. Without anti-dilution protection, your shares are now worth half as much. With anti-dilution provisions, your conversion price is adjusted downward, giving you more shares to offset the loss. The catch? Those extra shares come at the expense of founders and employees.
How It Works
- Investor buys preferred stock at agreed price (e.g., $10/share)
- Down round occurs — new investors buy at lower price (e.g., $5/share)
- Anti-dilution triggers — original investor's conversion price adjusts
- More shares issued to protected investor upon conversion
Types of Anti-Dilution Protection
Full Ratchet (Aggressive)
The harshest form. If any shares are issued at a lower price, the investor's conversion price drops to match that new price—regardless of how many shares are issued.
Example:
- Series A at $10/share → $1M investment = 100,000 shares
- Down round at $5/share (even for just 1 share)
- Full ratchet: Series A converts at $5 → now gets 200,000 shares
Full ratchet is rare in modern venture deals because it's extremely punitive to founders.
Weighted Average (Standard)
The most common form. The conversion price is adjusted based on both the new price AND the number of new shares issued. A small down round has less impact than a large one.
Formula:
New Price = Old Price × (Old Shares + New Money / Old Price) ÷ (Old Shares + New Shares)
There are two versions:
- Broad-based: Includes all common stock equivalents (options, warrants) in calculation — more founder-friendly
- Narrow-based: Only includes outstanding preferred shares — more investor-friendly
Pay-to-Play (Modern Approach)
Investors must participate in the down round to keep their anti-dilution protection. Those who don't participate may:
- Lose anti-dilution rights
- Convert to common stock
- Lose other preferred rights
This aligns incentives—investors who believe in the company continue supporting it.
Impact on Cap Tables
Anti-dilution provisions can devastate founder ownership in a severe down round:
| Scenario | Founder % Before | Founder % After |
|---|---|---|
| No anti-dilution | 40% | 32% |
| Weighted average | 40% | 28% |
| Full ratchet | 40% | 18% |
Illustrative example—actual impact varies by deal terms
Famous (Infamous) Examples
Square (2015)
Square went public at $9 per share—below its last private valuation of $15.46. Late-stage investors had anti-dilution ratchets that triggered, diluting earlier shareholders and employees.
Foursquare (2016)
Raised a down round at 60% lower valuation. Anti-dilution provisions kicked in, significantly diluting founders and early employees while protecting later investors.
Negotiating Anti-Dilution Terms
Founders should push for:
- Broad-based weighted average (not narrow-based or full ratchet)
- Pay-to-play provisions
- Carve-outs for equity compensation
- Time-based sunset provisions
Investors typically want:
- Narrow-based weighted average at minimum
- Full ratchet for late-stage deals
- No carve-outs
When Anti-Dilution Doesn't Apply
Most anti-dilution provisions exclude:
- Employee stock option grants
- Stock issued in acquisitions
- Stock issued to strategic partners
- Stock issued to lenders
Practical Takeaways
For founders: Anti-dilution terms are negotiable, especially in competitive fundraising environments. Push for broad-based weighted average and resist full ratchet at all costs. Understand the cap table impact before signing.
For investors: Anti-dilution protects your downside, but aggressive terms may hurt the company's ability to raise future rounds. Pay-to-play provisions ensure you keep skin in the game if things get tough.
Related Reading
- Dual-Class Stock — Another mechanism affecting founder control
- Drag-Along Rights — Forces alignment in exit scenarios
- Tender Offer — How investors exit private companies