Weighted Average Anti-Dilution
Anti-dilution adjustment formula balancing down-round share price with the volume of new shares issued.
Weighted average anti-dilution is the standard form of anti-dilution protection in modern venture capital transactions. When a company raises new capital at a price lower than existing preferred stockholders paid (a down round), weighted average anti-dilution adjusts the conversion price of the existing preferred stock downward—but by an amount that takes into account both the lower price and the quantity of new shares being issued, rather than fully resetting to the lower price as in full ratchet.
The weighted average formula calculates a new conversion price as a weighted average of the old price and the new price, weighted by shares outstanding. The formula is: New Conversion Price = Old Conversion Price × (A + B) / (A + C), where A = shares outstanding before the new issuance, B = shares the company would have received if the new shares were sold at the old price (i.e., proceeds ÷ old price), and C = actual new shares issued.
There are two variants: broad-based weighted average (the more founder-friendly version, including all authorized shares—including option pool—in the calculation) and narrow-based weighted average (including only actual outstanding shares, producing a larger adjustment favorable to investors). Broad-based is the industry standard.
Weighted average anti-dilution results in a partial adjustment that is proportional to the severity of the down round. A large down round issuance produces a larger conversion price reduction; a small issuance at a modestly lower price produces a modest adjustment. This proportionality makes it more economically fair than full ratchet.
Most standard term sheets from NVCA and other industry bodies default to broad-based weighted average anti-dilution, making deviations from this standard a negotiating point.
FAQs
What is the difference between broad-based and narrow-based weighted average?
Both use the same weighted average formula, but they differ in what shares are included in the denominator. Broad-based weighted average includes all fully diluted shares—common stock, preferred stock on an as-converted basis, options, warrants, and authorized but unissued option pool shares—producing a larger 'A' value in the formula, which results in a smaller, more conservative anti-dilution adjustment. Narrow-based includes only outstanding shares (excluding option pool and unissued shares), resulting in a larger anti-dilution adjustment more favorable to existing investors. Broad-based is standard in most modern VC term sheets.
Can anti-dilution provisions be waived?
Yes—anti-dilution provisions can be waived by the holders of the affected preferred stock class, typically by a majority or supermajority vote of that class. Anti-dilution waivers are commonly negotiated in down rounds as part of the overall financing terms: existing investors may agree to waive anti-dilution in exchange for other benefits (board seats, enhanced participation rights in the new round, or simply to facilitate a financing that keeps the company alive). Founders and companies should always request anti-dilution waivers from existing investors when structuring down rounds.
Does weighted average anti-dilution affect all shareholders equally?
No—anti-dilution protection only applies to preferred stockholders who hold it as a contractual right. Common stockholders (including founders and employees with options or restricted stock) receive no anti-dilution protection. In a down round, preferred stockholders with weighted average protection receive more common shares upon conversion (their conversion price drops), while common stockholders' ownership percentage is diluted by both the new shares issued and the increased conversion of preferred. This asymmetric protection is why down rounds are particularly painful for founders and early employees who primarily hold common stock.
Related Terms
Full Ratchet
Anti-dilution protection resetting preferred stock conversion price to the lowest price of any subsequent share issuance.
Ratchet
Mechanism adjusting investor ownership percentage upward if performance targets are missed post-investment.
Participating Preferred
Preferred stock that receives its liquidation preference and also participates in remaining proceeds alongside common stockholders.
