Anti-dilution is one of the clauses founders read as boilerplate and then meet again, painfully, in the first down round. It does not matter while the company’s price per share keeps rising. If a later round is priced below what an earlier investor paid, it decides how many extra shares that investor receives, and those shares come out of everyone else’s ownership.
What Anti-Dilution Protection Does
Attorney Casey Riggs, in a term-sheet negotiation series, describes a down round as a later issuance of stock at a price lower than the preferred issue price. The protection works through the conversion price: the price at which preferred converts into common, initially equal to the price the investor paid. A down round triggers a lower conversion price, so each preferred share converts into more common shares.
Nobody is handed cash. The investor’s slice of the pie is re-cut, and the people who bear the cost are the common holders (founders and employees) and, to some extent, the new investors.
The NVCA model term sheet, as Riggs summarises it, offers three alternatives: full ratchet, weighted average, and no price-based protection.
Full Ratchet
The conversion price drops to the price of the new issuance, full stop. Law firm Ashfords describes it as resetting the investor’s entry price to the down-round price “irrespective of the number of shares offered”: the adjustment is identical whether the company raises a small amount or a very large one at the lower price. It is the most protective term for the investor and, in Ashfords’ words, hurts founders, employees and ordinary shareholders the most. Michelmores makes the same point: the investor is treated as if it had bought at the lower price, however little is raised.
Both UK firms note it is out of step with the market: Ashfords calls it “not current market practice”, and Michelmores says it is very rarely seen in UK transactions. This is commentary from UK practitioners; we did not find a reliable survey figure for how often it appears in US term sheets, so we do not quote one.
Weighted Average
Weighted average takes the size of the down round into account. A small raise at a low price barely moves the conversion price; a large one moves it a lot. The NVCA formula, as reproduced by Riggs, is:
CP2 = CP1 × (A + B) ÷ (A + C)
- CP1 is the conversion price before the new issue; CP2 is the price after.
- A is the common stock deemed outstanding before the new issue.
- B is the money raised in the new issue divided by CP1 (the shares that money would have bought at the old price).
- C is the number of new shares actually issued.
If the new price equals CP1, B equals C and nothing changes. The lower the new price, the bigger the gap between C and B, and the bigger the adjustment.
Broad-based vs. narrow-based
The variable that quietly matters is what counts as A. Michelmores explains the split: narrow-based uses only currently issued share capital, while broad-based uses fully diluted capital, including unexercised options, and is less dilutive to ordinary shareholders. A larger A makes the fraction closer to 1, so the conversion price moves less. Riggs’s version of A includes outstanding common, preferred on an as-converted basis and options on an as-exercised basis. When you negotiate, “weighted average” is not one term but two, and you want the broad one.
Worked Example: One Down Round, Three Clauses
A hypothetical with round numbers, ignoring option-pool top-ups, debt and fees.
- Founders and employees hold 10,000,000 common shares (including options, so A counts them).
- Series A invested $5M for 5,000,000 preferred shares at $1.00, so the conversion price (CP1) is $1.00 and the shares convert 1:1.
- The company then raises $2M in a Series B at $0.50 per share: C = 4,000,000 new shares.
Full ratchet: CP2 = $0.50. Each Series A share now converts into 2 common shares, so Series A converts into 10,000,000 shares.
Broad-based weighted average: A = 15,000,000 (10M common plus 5M preferred as converted); B = $2M ÷ $1.00 = 2,000,000; C = 4,000,000. CP2 = $1.00 × (15M + 2M) ÷ (15M + 4M) = $0.8947. Series A converts into 5,000,000 ÷ 0.8947 ≈ 5,588,000 shares.
| Ownership after the Series B | Common | Series A | Series B |
|---|---|---|---|
| No anti-dilution | 52.6% | 26.3% | 21.1% |
| Broad-based weighted average | 51.1% | 28.5% | 20.4% |
| Full ratchet | 41.7% | 41.7% | 16.7% |
(Percentages are of the fully diluted, as-converted total: 19.0M, 19.6M and 24.0M shares respectively.)
Weighted average costs the founders about 1.6 points compared with no protection. Full ratchet costs them about 11 points and hands the Series A a stake equal to the common’s, though the Series A’s cash in the company has not changed. It also hurts the new investor, which is why a full ratchet in an existing series can make a down round harder to close: Riggs notes that the new investors fund the company while the old ones collect extra shares without putting in cash.
For comparison, Riggs’s own example (1,000,000 common, 1,000,000 Series A shares at $1.00, then 1,000,000 Series B shares at $0.50) gives a Series A conversion price of $0.50 under full ratchet and about $0.8333 under weighted average. Our numbers differ because the share counts do; the pattern is the same.
How Often Does This Come Up?
Cooley’s Q2 2026 venture financing report covered 166 financings its clients handled and put down rounds at 12.1% of them, up from 10.9% a quarter earlier, with pay-to-play provisions in 8.4% (7% in Q1). That is one law firm’s deal flow, not the whole market, but it is a reminder that a clause about down rounds is a live term, not a theoretical one. Cooley’s report does not break out anti-dilution terms, so do not read those percentages as a measure of how common each variant is.
What Founders Should Do
- Ask for broad-based weighted average and confirm “broad.” The definition of A in the charter is where the money moves.
- Resist full ratchet. If an investor insists, Ashfords suggests limiting it: a time limit after which weighted average applies, a price floor, an ownership cap, carve-outs for founders and employees, or pay-to-play.
- Understand pay-to-play. It conditions an investor’s anti-dilution on participating in the down round, which aligns incentives with funding the company; Ashfords lists it as a mitigation.
- Don’t over-price the round. Michelmores’ advice is to avoid an optimistic valuation, since that makes a down round more likely. See the startup valuation guide and bootstrapping vs. venture capital.
- Model it, together with the preference stack. Anti-dilution changes share counts; the liquidation preference decides who is paid from the proceeds. Run both before signing.
- Know what converts later. SAFEs and convertible notes become preferred at the next priced round and bring their terms with them, and employee options are affected by option-pool and equity decisions.
FAQ
What is anti-dilution protection?
A term in an investor’s preferred stock that lowers its conversion price if the company later sells shares at a lower price, so the investor converts into more common shares and keeps more of its ownership.
What is the difference between full ratchet and weighted average?
Full ratchet resets the conversion price to the new price regardless of how many shares are sold. Weighted average adjusts it in proportion to the size of the down round, so a small raise moves the price little.
What does broad-based mean?
The share count in the formula includes everything fully diluted (common, preferred as converted, options). Narrow-based counts less, which produces a bigger adjustment and more dilution for common holders.
Does anti-dilution apply to employee options?
Not directly. It attaches to the investors’ preferred stock. Employees feel it indirectly because the extra shares issued to the investor dilute common holders.
Does anti-dilution give investors their money back?
No. It changes share counts, not cash. The money-back mechanics are in the liquidation preference.
This guide is general information, not legal advice; have a startup lawyer read the certificate of incorporation, where the formula actually lives, before you sign. For a book-length treatment of term sheets, Brad Feld and Jason Mendelson’s Venture Deals is a standard reference. More in the finance section on FutureSharks.
