An anti-dilution provision adjusts the conversion price of preferred shares when a company issues new shares at a price below the original round.
Plain definition
An anti-dilution provision sits inside the term sheet of a preferred share round. It adjusts the conversion ratio of preferred shares when the company later issues new shares at a price lower than the price the protected investor paid.
Two structures are common. Full ratchet adjusts the preferred conversion price all the way down to the new lower price, regardless of how many new shares were issued. Weighted-average adjusts the conversion price by a formula that accounts for both the new price and the size of the new issuance. Weighted-average is the more common structure. Full ratchet is more aggressive and more punishing to founders.
An anti-dilution provision is the rule that decides who pays for a down round. The structure of the provision decides how much.
What goes wrong
Founders model up-round scenarios because that is the success case. The dilution math of a down round only gets built when the down round is already under consideration. By then the conversion ratchet is already triggered.
In a clean reduction, full ratchet looks like a small adjustment. After two rounds, three follow-ons, and a partial down round, the ratchet recalculation can hand the preferred stack a meaningful piece of the founder's equity.
A down round triggers anti-dilution. Anti-dilution favors existing investors. Existing investors sit on the board. Pressure to take a deal at the lower number can grow when the math benefits the people approving it.
Anti-dilution can be waived. Investors will sometimes agree to waive it for a strategic reason. The waiver almost always comes paired with another concession: more board control, a heavier preference, a longer vesting reset, or a new protective term.
Business owner questions
Bigger picture
Liquidation preference decides exit payout order. Anti-dilution decides who absorbs a down round before the exit ever arrives.
Related structure Preemptive RightsPreemptive rights protect investor ownership percentage in new issuances. Anti-dilution protects investor share value when those issuances price low.
Related structure Capital Raise That Cost ControlThe case note of investor protections compounding against founder equity inside a real founder-led company.
Related reading
How the choice of capital changes which protections sit on top of the cap table.
Related readingTiming decisions that shape what investors can demand inside the term sheet.
Related readingWhy capital structure decisions made early decide what later rounds and exits actually pay.
