Educational only — not investment, legal or tax advice.
Nobody plans a down round, a financing at a lower share price than the last one. But when rates rise and funding tightens, they happen more often, and that is when a clause most founders skimmed suddenly matters: anti-dilution protection.
What it does
Anti-dilution protection adjusts the price at which an investor’s preferred shares convert into common shares if the company later sells shares more cheaply. A lower conversion price means the investor gets more common shares, and everyone without that protection (usually founders, employees and common holders) absorbs the difference.
There are two main versions, and the gap between them is large.
- Full ratchet: the investor’s conversion price drops all the way to the new, lower price, no matter how few shares are sold at it.
- Broad-based weighted average: the conversion price drops partway, weighted by how much new money comes in at the lower price relative to the company’s total shares. This is the more common and more founder-friendly version.
Worked example
Example, hypothetical numbers.
- Series A investors paid $4M at $2.00 per share for 2,000,000 preferred shares.
- The company has 10,000,000 shares outstanding on a fully diluted basis before the next round.
- A down round raises $2M at $1.00 per share.
Full ratchet. The Series A conversion price falls to $1.00. The Series A now converts into 4,000,000 common shares, double what they bought.
Broad-based weighted average. The new conversion price is:
$2.00 × (10,000,000 + 1,000,000) ÷ (10,000,000 + 2,000,000) = about $1.83
Here 1,000,000 is the number of shares the $2M would have bought at the old $2.00 price, and 2,000,000 is the number actually issued at $1.00. The Series A converts into about 2,182,000 shares.
| Version | Series A converts into | Extra shares vs original |
|---|---|---|
| None | 2,000,000 | 0 |
| Broad-based weighted average | ~2,182,000 | ~182,000 |
| Full ratchet | 4,000,000 | 2,000,000 |
Under full ratchet, a small, cheap round can transfer a large slice of the company from founders to earlier investors. That is why it is rare in standard deals and a red flag when it appears.
What to look for in your term sheet
- “Broad-based weighted average” is the version to expect. “Narrow-based” counts fewer shares and is less favourable to you.
- Push back on full ratchet. If it is non-negotiable, ask for it to expire after a short period or to apply only below a certain price.
- Check the carve-outs. Option grants, conversions and certain strategic issuances should not trigger the adjustment.
- Model the downside. Ask your lawyer to run a down-round scenario before you sign, not when you are in one.
From the investor’s side of the table
Investors ask for anti-dilution because they priced the risk at one valuation and want some protection if that price proves too high. That is reasonable. Full ratchet goes further than protection, though: it shifts the cost of a bad market almost entirely onto the founders and team you need to keep motivated through it.
The short version
Broad-based weighted average is standard. Full ratchet can turn a small down round into a large loss of ownership. Know which one you signed.
Sources
- Cooley GO glossary: Broad-based weighted average anti-dilution protection
- Cooley GO glossary: Full ratchet
- NVCA model legal documents (Certificate of Incorporation)
Written by Fabian Cisneros. Educational only — not investment, legal or tax advice. See the full disclaimer.
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