An anti-dilution provision protects preferred stockholders when a company sells new shares at a lower price than they originally paid, by adjusting the conversion price on their preferred stock so they end up with more common shares on conversion. The two common approaches are full ratchet, which resets the conversion price to match the new, lower price outright, and weighted average, which blends the old and new prices based on how many new shares were issued.
For an SPV investing through preferred stock, the choice between the two can change how much of a down round’s damage the SPV’s investors absorb. This guide compares the mechanics, works through a numeric example, and covers how each version typically gets negotiated.
The terms live in the company’s certificate of incorporation, so they apply the same way to every preferred holder in that class, including an SPV that pooled money from many individual investors into one line on the cap table.
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What an anti-dilution provision does
Anti-dilution provisions sit inside a company’s certificate of incorporation and apply to preferred stock, not common stock or SAFEs. They activate when the company issues new stock at a price below what a class of preferred stockholders paid, an event usually called a down round. Rather than changing how many shares an investor holds directly, the provision adjusts the conversion price used when preferred stock converts into common stock, which increases the number of common shares each preferred share converts into.
Provisions like this are one reason preferred stock carries more rights than common stock. See Why Preferred Stock Is Preferred Over Common Stock for the rest of that comparison.
Full ratchet anti-dilution
Full ratchet is the more aggressive version. It resets the conversion price of the existing preferred stock to match the new, lower price of the down round, no matter how many new shares were sold. Even a small new issuance at a low price fully repriced the earlier round, which can badly dilute the founders and any investors who are not covered by the ratchet.
Because full ratchet is so punishing to founders and later investors, it is uncommon in venture deals outside of situations where an investor has significant leverage over the terms, such as a rescue financing where the company has few other options and needs the round to close quickly.
Weighted average anti-dilution
Weighted average anti-dilution adjusts the conversion price using a formula that accounts for both the price of the new shares and how many shares were issued relative to the company’s existing share count. A small down round issuance produces a small adjustment; a large one produces a bigger adjustment. This makes the outcome proportional to the actual dilution the down round caused, rather than treating a token issuance the same as a full recapitalization.
Broad-based versus narrow-based
Weighted average formulas come in two common versions. Broad-based counts all outstanding shares, including common stock, options, and other convertible securities, in the calculation, which produces a smaller, gentler adjustment. Narrow-based counts only the preferred stock of the same series, which produces a larger adjustment because the same new issuance is being divided across a smaller base. Broad-based weighted average is the version most commonly seen in standard venture term sheets.
Comparing the two in a down round
For example, suppose an SPV holds preferred stock purchased at $2.00 per share, and the company later raises a down round at $1.00 per share, issuing new shares equal to 20 percent of the company’s fully diluted shares outstanding.
| Full ratchet | Broad-based weighted average | |
|---|---|---|
| Original conversion price | $2.00 | $2.00 |
| New conversion price | $1.00 | Approximately $1.80 |
| Effect on the SPV’s shares on conversion | Doubles | Increases by roughly 11 percent |
The broad-based weighted average number in this example is illustrative rather than an exact calculation, since the precise result depends on the company’s full capitalization at the time of the down round. The pattern holds regardless of the exact figures: full ratchet gives existing preferred holders a much larger adjustment than weighted average for the same down round.
How this affects an SPV’s return
If the SPV holds the preferred stock that carries the anti-dilution right, a down round adjustment increases the SPV’s eventual share count and can meaningfully improve outcomes for its investors if the company later recovers. For example, if an SPV’s preferred stock carries broad-based weighted average protection and the company later recovers to a higher valuation, the SPV’s larger share count from the adjustment converts into more common stock at exit than it would have without the protection. An SPV holding common stock, or preferred stock in a class without the right, simply absorbs the dilution from the new round with no offset. Confirm which class of stock the SPV is purchasing, and whether that class carries an anti-dilution right, before the deal closes.
Negotiating anti-dilution as an investor
Founders and later investors generally prefer broad-based weighted average because it produces a proportional, less punishing adjustment. Early investors with strong leverage sometimes push for narrow-based weighted average or, in a distressed situation, full ratchet. A pay-to-play provision is often paired with anti-dilution protection, requiring existing investors to participate in the down round to keep their anti-dilution rights, which discourages investors from relying on the protection without also supporting the company through the rough round.
Anti-dilution terms are set in the term sheet before a deal is drafted into definitive documents, so review them alongside valuation and liquidation preference rather than in isolation. See Term Sheet Guide for Startup Founders for how these terms fit into the rest of a term sheet, and Calculating Post-Money Valuation for Investments for how valuation and dilution interact.
When these provisions get triggered
Anti-dilution provisions only activate on a down round, meaning new stock sold at a price below the applicable preferred price. They typically do not apply to option pool increases approved by the board, shares issued under existing convertible notes or SAFEs converting at their stated terms, or shares issued for acquisitions and equipment financing, since most certificates of incorporation carve these out as exempted issuances. Read the exact carve-out list in the certificate of incorporation before assuming a particular issuance will or will not trigger the adjustment.
Frequently asked questions
What is the difference between full ratchet and weighted average anti-dilution?
Full ratchet resets the conversion price to match the new, lower price regardless of how many shares were issued. Weighted average blends the old and new prices based on the size of the new issuance, producing a smaller, proportional adjustment.
Which type of anti-dilution is more common?
Broad-based weighted average is the most common version in standard venture financings. Full ratchet is rare outside of distressed or rescue financings where an investor has significant negotiating leverage.
Does anti-dilution protection apply to common stock?
No. Anti-dilution provisions are a right attached to preferred stock through the certificate of incorporation. Common stockholders have no equivalent contractual protection against a down round.
What is a pay-to-play provision?
A pay-to-play provision requires existing preferred investors to participate in a later financing round to keep certain rights, including anti-dilution protection. Investors who sit out can lose those rights or have their preferred stock converted to common.
How Syndicately fits
Syndicately forms and administers the SPV that holds your position, tracks the terms of each investment, and prepares K-1s and investor updates as the underlying company’s capitalization changes. See how Syndicately’s services work for a deal that includes preferred stock with anti-dilution rights.
This article is general information, not legal or investment advice. Anti-dilution mechanics depend on the exact language in the certificate of incorporation, so have counsel review the specific terms before you rely on them.
