Anti-dilution protection adjusts the conversion price of preferred stock if the company later issues shares at a lower price (a “down round”). It exists to protect early investors from being mathematically penalized when later investors buy shares at a cheaper price.

The three common flavors

1. Broad-based weighted average (market standard)

Adjusts the conversion price using a formula weighted by all existing shares (common, preferred, options) plus new shares in the down round.

Formula: New conversion price = Old price × (A + B) / (A + C)

Where:

• A = Total shares outstanding (fully diluted) before the down round.
• B = Shares that would be issued at the old price for the down round amount.
• C = Shares actually issued in the down round.

This is founder-friendly-ish because it spreads dilution.

2. Narrow-based weighted average

Same formula, but A includes only the preferred shares (not common + options). More protective of investors, more dilutive of founders.

3. Full ratchet

Adjusts the conversion price all the way down to the new round’s price — regardless of the amount raised. Ultra-investor-friendly, founder-punitive.

Worked example

Setup:

• Series A: $10M invested at $1.00/share → 10M preferred shares.
• Pre-round outstanding (fully diluted): 20M shares.
• 9 months later, the company raises a down round at $0.50/share — $2M raised, issuing 4M new preferred shares.

Full ratchet:

• Series A conversion price drops to $0.50. Series A investors now effectively hold 20M shares — doubling their ownership at the expense of common.

Broad-based weighted average:

• New price = $1.00 × (20M + $2M/$1.00) / (20M + 4M) = $1.00 × (20M + 2M) / 24M ≈ $0.917.
• Series A’s effective share count increases by ~9%, not 100%.

Difference in dilution to founders: Full ratchet creates ~10M extra preferred shares to investors. Broad-based weighted creates ~900K. That’s a 10x difference in founder dilution.

Pay-to-play provisions

A pay-to-play clause says: anti-dilution protection is available only if the investor participates pro-rata in the down round.

• Protects the company’s ability to raise follow-on capital.
• Penalizes investors who refuse to support the company.
• Common in distressed rounds.

What to negotiate

1. Broad-based weighted average (never accept full ratchet unless you have no alternative).
2. Pay-to-play — helps future rounds close cleanly.
3. Exceptions to anti-dilution — should exclude option pool grants, M&A-related shares, and similar non-financing issuances.

Practical takeaway

1. Founders: Broad-based weighted average is standard and should be non-negotiable as the floor.
2. Investors: Understand that full ratchet in a term sheet is a visible founder-hostility signal and can damage deal flow.
3. Operators: If a down round is likely, negotiate pay-to-play upfront to avoid future pain.

Further reading

• NVCA model documents: https://nvca.org/model-legal-documents/