Anti-Dilution Protection: Full Ratchet vs. Weighted Average
A down round would otherwise dilute earlier preferred investors with no compensation for the lower price. Anti-dilution provisions soften that by resetting their conversion price, and most deals use the milder of two standard methods.
What is anti-dilution protection?
Anti-dilution protection adjusts a preferred investor's conversion price downward when a company raises a later round at a lower price. A lower conversion price means each preferred share converts into more common shares, partly offsetting the down round. Full ratchet resets the price all the way to the new round's price; broad-based weighted average, the market standard, scales the adjustment to the size of the round.
Key takeaways
- The trigger is a down round: a new round priced below what an earlier preferred round paid.
- The mechanism is a conversion-price adjustment, not an immediate issuance of new shares.
- Full ratchet resets the conversion price to the new round price regardless of how small that round is.
- Broad-based weighted average: new conversion price = old price × (A + B) ÷ (A + C).
- Broad-based weighted average is the market standard because full ratchet is punitive to founders and common holders.
- Neither version prevents dilution outright; it only softens the effect.
What does anti-dilution protection protect against?
- Anti-dilution protection
- A preferred stock provision that lowers the conversion price of an existing preferred round when a company later issues shares at a lower price, increasing the number of common shares those preferred shares convert into.
A down round is a new financing round priced lower per share than an earlier round paid. Without any protection, an earlier preferred investor would simply be diluted at the new, lower price like everyone else, with no adjustment for having paid more for their original shares. Anti-dilution provisions, standard in preferred stock financing terms, exist specifically to soften that blow for existing preferred holders.
Mechanically, these provisions don't hand out new shares immediately. They adjust the preferred stock's conversion price, the price used to determine how many common shares each preferred share converts into, typically at an exit or IPO. A lower conversion price means more common shares per preferred share at conversion.
How does full ratchet anti-dilution work?
Full ratchet anti-dilution resets the earlier investor's conversion price all the way down to the new round's price per share, regardless of how many shares were actually sold in the down round. Even a very small down round triggers the full reset. It's the most protective version for the investor holding the right, and correspondingly the most dilutive to founders and other common holders, which is why it's relatively uncommon in practice outside of unusually investor-favorable deals.
How does broad-based weighted average anti-dilution work?
Broad-based weighted average anti-dilution, the version used in most venture deals, adjusts the conversion price by a formula that accounts for both the size of the price drop and how large the down round is relative to the company's existing fully diluted share count. A small down round produces a proportionally small adjustment rather than a full reset.
where A is fully diluted shares outstanding before the new round, B is the number of shares the new round's proceeds would have bought at the old conversion price, and C is the actual number of new shares issued in the down round. (“Broad-based” means A includes the full fully diluted share count, option pool included; a less common “narrow-based” variant excludes the option pool from A, producing a bigger, more investor-favorable adjustment.)
Worked example: an earlier round's conversion price is $5.00 per share, with 10mm fully diluted shares outstanding before the new round (A = 10mm). A down round raises $2mm at $2.00 per share, issuing 1mm new shares (C = 1mm). B is the shares that $2mm would have bought at the old $5.00 price: $2mm ÷ $5.00 = 0.4mm.
Compare that to full ratchet, which would have reset the conversion price straight down to $2.00, a far bigger hit to common shareholders.
| Full ratchet | Broad-based weighted average | |
|---|---|---|
| Adjustment size | Full reset to the new round price | Scaled to the size of the down round |
| Sensitive to round size? | No, even a tiny round triggers a full reset | Yes, a small round produces a small adjustment |
| Worked example result | $5.00 conversion price resets to $2.00 | $5.00 conversion price falls to about $4.73 |
| Impact on founders and common | Severe | Moderate |
| How common in practice | Rare, seen in investor-favorable deals | Market standard in most venture financings |
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What triggers anti-dilution protection?
A down round: a new financing round priced lower per share than an earlier preferred round paid. The provision adjusts the earlier round's conversion price to partially compensate existing preferred holders for the lower valuation.
What's the difference between full ratchet and weighted average anti-dilution?
Full ratchet resets the earlier investor's conversion price all the way down to the new round's price, no matter how small the down round is. Weighted average adjusts the conversion price by a formula that accounts for both the price drop and the relative size of the new round, producing a smaller, more proportionate adjustment.
Why do most venture deals use broad-based weighted average rather than full ratchet?
Full ratchet is dramatically more dilutive to founders and common shareholders, even from a small down round, which makes it harder for a company to attract new talent and future investors and can feel disproportionate to investors themselves. Broad-based weighted average is seen as a more balanced compromise, protective of the investor without being punitive to everyone else, which is why it's the market standard in most venture financings.
How does anti-dilution protection actually work mechanically?
It adjusts the preferred stock's conversion price, the price used to determine how many shares of common stock each preferred share converts into, typically at an exit or IPO. A lower conversion price means each preferred share converts into more common shares, rather than the company issuing brand new shares to the investor immediately.
Does anti-dilution protection prevent dilution entirely?
No. It only partially offsets the effect of a lower valuation by adjusting the conversion price; the investor's percentage ownership still typically declines in a down round, just by less than it would have without the protection.