Anti-Dilution Protection

VC investors pay a specific price per share based on the company's valuation at the time of investment. If the company subsequently raises capital at a lower valuation (a down round), the earlier investor's shares are effectively worth less than what they paid. Anti-dilution provisions compensate the earlier investor by reducing their conversion price, which increases the number of common shares they receive upon conversion. This protects investors from bearing the full economic impact of a valuation decline between rounds.

Full ratchet is the most aggressive form of anti-dilution protection. It adjusts the investor's conversion price down to exactly the new, lower price per share — regardless of how many shares are issued in the down round. Even if the down round is tiny, the original investor's entire position is repriced. Full ratchet is very punitive to founders and other common holders because it transfers a large amount of ownership to the protected investor. It is relatively rare in practice and typically seen only in bridge loans or distressed situations.

Weighted average anti-dilution is the market standard and is more balanced. It adjusts the conversion price based on both the price and the size of the down round — a small down round causes a smaller adjustment, while a large down round at a very low price causes a bigger adjustment. There are two variants: broad-based (which includes options and warrants in the denominator, producing a smaller adjustment) and narrow-based (which excludes them, producing a larger adjustment). Broad-based weighted average is the most common form in VC term sheets.

Anti-dilution adjustments increase the protected investor's ownership at the expense of common shareholders — primarily founders and employees. The impact is visible on the cap table as the protected investor's diluted shares outstanding increase. In a severe down round with full ratchet protection, founders can lose a significant portion of their ownership. This is why experienced founders negotiate for broad-based weighted average anti-dilution and resist full ratchet provisions. Some investors agree to 'pay-to-play' provisions that require them to invest pro-rata in the down round to retain their anti-dilution protection, which aligns incentives.