Anti-Dilution Protection
Provisions in preferred stock terms that protect investors from dilution if the company raises money at a lower valuation in a future down round.
Anti-dilution protection is a contractual right granted to preferred stockholders that adjusts their conversion price downward — entitling them to additional shares — if the company subsequently issues equity at a lower price per share (a 'down round'). It compensates early investors for paying more than later investors and protects against the most harmful form of dilution.
There are three main types: Full Ratchet (most investor-favorable): the conversion price is reset to the new, lower round price regardless of how small the down round is. Even a tiny down round triggers full adjustment, massively diluting founders. Broad-Based Weighted Average (market standard): the conversion price is adjusted using a formula that considers the number of shares issued in the down round relative to total shares outstanding — resulting in a partial adjustment proportional to the severity and size of the down round. Narrow-Based Weighted Average: similar to broad-based but uses a narrower share count, providing more investor protection than broad-based.
Broad-based weighted average is the nearly universal standard in modern venture deals because it is fair to both parties — investors get protection from genuine down rounds while founders aren't wiped out by a minor technical down round. Full ratchet is rare except in extreme investor-favorable conditions or highly distressed bridge financings.
Pay-to-play provisions, often paired with anti-dilution, require investors to participate in down rounds to maintain their anti-dilution protection — incentivizing continued investor support rather than allowing passive investors to benefit from anti-dilution without contributing new capital.
Anti-dilution is triggered only by actual issuances at lower prices — it is not triggered by changes in 409A valuations or public market prices for publicly traded companies.
FAQs
What is the broad-based weighted average anti-dilution formula?
Adjusted Conversion Price = CP × (A + B) ÷ (A + C), where CP is the current conversion price, A is the number of shares outstanding before the new issuance, B is the number of shares that the new offering proceeds would purchase at the current conversion price (i.e., proceeds ÷ CP), and C is the actual number of new shares issued. The broad base (A) includes all shares, options, warrants, and convertibles.
Does anti-dilution apply to option grants?
Standard option grants from an authorized equity plan are typically excluded from anti-dilution calculations, because including them would trigger adjustment every time an employee option is granted. Anti-dilution applies to equity issuances below the conversion price — not to routine equity compensation from the approved option pool.
How can founders negotiate around anti-dilution?
Founders can negotiate for broad-based weighted average (vs. full ratchet), inclusion of pay-to-play provisions requiring investors to participate in down rounds to keep anti-dilution protection, carve-outs for certain issuances (convertible note conversions, employee grants), and sunset provisions that eliminate anti-dilution after a specified period.
Related Terms
Dilution
The reduction in existing shareholders' ownership percentage caused by the issuance of new shares to investors, employees, or through conversion of instruments.
Priced Round
A funding round in which the company's value is formally determined and investors receive shares at a specific price, establishing a definitive valuation.
Cap Table
A spreadsheet or software record showing all equity ownership in a company, including shares, options, warrants, and convertible instruments.
Liquidation Preference
A provision giving preferred stockholders the right to receive their investment back before common shareholders in a company sale or liquidation.
