What Is an Anti-Dilution Clause?
An anti-dilution clause protects investors from losing value if the company raises future rounds at a lower valuation. Learn how these provisions work.
Key Takeaways
- Anti-dilution clauses adjust an investor's conversion price downward if the company issues shares at a lower price in a future round.
- The two main types are full ratchet (most aggressive) and weighted average (more common and balanced).
- Anti-dilution provisions can significantly increase founder dilution in a down round.
Why anti-dilution clauses exist
Investors paying USD 10 per share in Series A want protection if the company later issues Series B shares at USD 5. Without anti-dilution protection, their Series A shares are economically disadvantaged relative to the cheaper Series B shares. Anti-dilution provisions adjust the Series A conversion price downward, giving the Series A investor additional shares to compensate for the lower valuation.
Full ratchet vs weighted average
Full ratchet is the most aggressive form: the conversion price drops to match the new lower price exactly, regardless of how many shares are issued in the down round. Weighted average is more common and fairer; it adjusts the conversion price based on both the new price and the number of new shares issued. Broad-based weighted average, which includes all shares and options in the calculation, is the market standard.
Impact on founders in a down round
In a down round, anti-dilution provisions create additional shares for protected investors, and those additional shares come at the expense of common shareholders, primarily founders and employees. A severe down round with full ratchet protection can reduce founder ownership dramatically. This is one reason experienced founders push for broad-based weighted average anti-dilution as the standard provision.
Negotiating anti-dilution terms
Accept that investors will require some form of anti-dilution protection. Push for broad-based weighted average, which is industry standard and balances both interests. Resist full ratchet provisions unless there are truly no alternatives. Negotiate pay-to-play provisions that require investors to participate in the down round to benefit from anti-dilution protections, preventing passive investors from gaining at your expense.