Anti-dilution Provisions

Anti-dilution provisions are protective terms in preferred stock agreements that adjust an investor's conversion price downward if the company issues shares at a lower price than the investor originally paid. In simple terms: if the company's valuation drops and new investors get cheap shares, existing preferred investors get extra shares (or an adjusted price) to compensate.

There are two main types. "Full ratchet" anti-dilution is the most aggressive — it adjusts the investor's conversion price all the way down to match the new, lower price, regardless of how many shares are issued in the down round. "Weighted average" is more common and more founder-friendly — it adjusts the price based on a formula that accounts for both the new price and the number of new shares issued. The smaller the down round relative to the company, the less the adjustment.

Weighted average anti-dilution comes in two flavors: broad-based (which includes all outstanding shares, options, and convertible securities in the calculation) and narrow-based (which excludes some categories). Broad-based weighted average is the startup standard and produces the smallest adjustment — which is why founders prefer it. Full ratchet is rare in venture deals and is generally considered an aggressive term that signals an investor-unfriendly deal.

Anti-dilution provisions mainly come into play during down rounds — when your company raises money at a lower valuation than the previous round. While nobody plans for a down round, they happen (especially in tough economic climates). Understanding your anti-dilution terms tells you how much additional dilution founders and employees will face if the company has to raise at a lower price. Full ratchet provisions can be devastating to common shareholders in a down round, while broad-based weighted average provides a more balanced adjustment.