Anti-Dilution Provisions: How to Protect Your Equity
Anti-dilution provisions protect investors when a company raises money at a lower valuation than a previous round (a down round). Understanding these provisions is critical for founders - they can dramatically affect how much dilution you face if your company's trajectory changes.
Full-Ratchet Anti-Dilution
Investor-friendlyIf new shares are issued at a lower price than the previous round, the investor's conversion price is reset to the new lower price - as if they had invested at the lower price all along.
This is the most aggressive form. It can severely dilute founders and earlier investors in a down round. If $2M was raised at a $10M valuation and the company then raises at a $3M valuation with full-ratchet protection, the Series A investor gets dramatically more shares, diluting everyone else heavily.
When common: Less common today. Was more prevalent in early 2000s. Occasionally appears in distressed financing situations.
Weighted-Average Anti-Dilution (Broad-Based)
BalancedAdjusts the conversion price based on a weighted average of both the old and new share prices, taking into account the number of shares issued in the new round. Broad-based includes all shares in the calculation.
Much less punitive than full-ratchet. The adjustment is proportional to the size of the down round. A small down round has a small conversion adjustment. This is the most common form of anti-dilution protection in venture deals.
When common: Standard in most Series A and later term sheets. Founders should accept this but push back on full-ratchet if offered.
Weighted-Average Anti-Dilution (Narrow-Based)
Slightly investor-friendlySimilar to broad-based weighted-average but uses a narrower definition of shares in the denominator, excluding some classes. This gives investors a slightly more favourable adjustment.
Falls between full-ratchet and broad-based weighted-average in impact. Less common than broad-based. Founders should push for broad-based weighted-average.
When common: Occasionally negotiated where investors have stronger leverage.
No Anti-Dilution
Founder-friendlyThe investor accepts that their ownership percentage may be diluted in a future round at any price. They hold preferred shares that convert at a fixed ratio regardless of subsequent valuations.
Best case for founders. Rare except in very hot deals where founders have substantial negotiating leverage. Common in revenue-based financing structures.
When common: Occasionally in hot seed rounds. Some angel investments. Revenue-based financing.
What Founders Can Negotiate
Push for broad-based weighted-average
This is the market standard and founders should not accept full-ratchet unless there is no alternative. If an investor insists on full-ratchet, use it as a signal about how they will behave in difficult situations.
Carve out issuances from anti-dilution triggers
Standard carve-outs include employee option pool grants, equipment financings, and strategic partnership shares. Make sure these are excluded from the anti-dilution calculation so ordinary business operations do not trigger the provision.
Sunset clauses on anti-dilution
Some term sheets include a clause that anti-dilution provisions expire after a certain date or upon the company reaching a specific milestone. These are rare but worth requesting in founder-friendly markets.
Pay-to-play provisions
A pay-to-play clause requires investors to participate in future rounds to maintain their anti-dilution protection. Investors who do not invest in a down round convert their preferred shares to common shares, losing the anti-dilution benefit. This aligns incentives between investors and founders.
Key takeaway
Anti-dilution provisions only become relevant if you raise a down round. The best protection against their activation is raising each round at a higher valuation than the last. However, markets and company trajectories are unpredictable. Understanding what you have agreed to in your cap table before you sign is the most important thing a founder can do. Always have a startup-specialist attorney review any term sheet before signing.