Anti-Dilution Protection
Anti-dilution protection is a term of preferred shares that adjusts the investor's conversion price downward if the company later sells shares at a lower price, so that the investor ends up with more common shares than it originally paid for and its stake is protected against the down round. A full ratchet resets the price to the new round's; a weighted-average ratchet — the usual form — adjusts it in proportion to how much was raised at the lower price.
- Also known as
- Anti-dilution, Ratchet, Weighted-average anti-dilution, Full ratchet
- Used at
- every venture and growth term sheet; triggered by a down round, a discounted issue, or sometimes an IPO below the round price (an "IPO ratchet")
- Binding
- yes — in the articles or charter as a feature of the preferred class; it operates automatically when a dilutive issue occurs
- Typical forms
- broad-based weighted average (standard — adjusts the conversion price by a formula weighted by all shares outstanding), narrow-based weighted average (weighted by fewer shares, more investor-friendly), and full ratchet (the conversion price becomes the new price, however few shares were sold)
- Typical carve-outs
- option grants under an approved pool, conversion of existing instruments, shares issued in acquisitions or to lenders — issues that are not "dilutive" for this purpose
- Parties
- the protected investors, the founders and employees whose ordinary shares absorb the adjustment, and the new investors in the down round, who must price it knowing the ratchet will fire
How anti-dilution protection works in practice
A fund buys preferred shares at €5.00, convertible one-for-one into ordinary shares. The company later raises at €2.50. Without protection, the fund's shares are now worth half what it paid and its percentage falls like everyone's. With a full ratchet, its conversion price becomes €2.50: each preferred share now converts into two ordinary shares, its percentage roughly doubles, and the founders' and employees' shares are diluted twice — once by the new money, once by the ratchet. With a broad-based weighted average, the conversion price falls to a figure between €5.00 and €2.50, weighted by how many shares were sold at the low price relative to the company's total: a small down round moves it a little, a large one more.
The protection shifts the cost of a down round from the protected investors to the ordinary shareholders — which means founders and staff, who can be left with very little of a company that is still operating. It also complicates the down round itself: a new investor pricing at €2.50 must model the ratchet's dilution to know what its money buys, and often insists that earlier investors waive their protection as a condition of the round. In the fintech down rounds of 2022–2023, that waiver negotiation was where most of the time went.
Founders accept weighted-average protection as standard and refuse full ratchets; they also negotiate a "pay-to-play" — an investor keeps its protection only if it invests its pro rata in the down round.
Example
A fintech's Series B investor paid €20m at €5.00 a share for 4m preferred shares — 20% of a 20m-share company. A year later the company raises €10m at €2.50 (4m new shares). Under a broad-based weighted average, the conversion price adjusts to €5.00 × (20m + 2m) ÷ (20m + 4m) = €4.58: the B's 4m preferred now convert into 4.36m ordinary — 17.9% of the enlarged 24.4m-share company instead of the 16.7% it would have held with no protection. Under a full ratchet, the price becomes €2.50, the B converts into 8m ordinary, and it holds 28.6% of a 28m-share company — while the founders' 8m shares fall from 40% to 28.6%. The new investor, seeing the full ratchet, had made its €10m conditional on the B waiving it; the B agreed to weighted average in exchange for a board seat.
Common mistakes
- Accepting a full ratchet because the round is "never going to be a down round". - A weighted-average formula with a narrow base, which is a ratchet in disguise. - No carve-outs, so option grants and acquisition shares trigger the adjustment. - New investors pricing a down round without modelling the ratchets that fire on it. - Founders learning what the term does at the round that triggers it.