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.

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.