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Anti-dilution

If a company later raises money at a lower share price, earlier investors are often given extra shares to make up the difference. Put in the old and new prices to see how many, and who pays for them.

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Anti-dilution

Raising at a lower price than last time is called a down round. Investors from the earlier, more expensive round usually have a clause protecting them: the company retroactively treats their money as though it had bought shares more cheaply, and issues them the extra shares that difference is worth. Nobody puts in new money for those shares, so everyone without the clause, which means founders and employees, is diluted to cover it.

Broad-based, narrow-based and full ratchet are three words that look interchangeable and are not. A full ratchet can reprice an entire earlier round off a tiny down round; a broad-based weighted average barely moves. That single phrase is worth negotiating.

Worked example

An investor put in €2m at €0.80 a share. The company later raises €1m at €0.40. Under a broad-based weighted average the conversion price falls to about €0.733 and they gain roughly 227,000 shares. Under a full ratchet it falls all the way to €0.40, and they gain 2,500,000, which is eleven times as many, from the same down round.

How to calculate anti-dilution protection in a down round

Adjusted conversion price

€0.7333
Extra shares issued227,273
Currency

Mechanism

Severity

  • Broad-based weighted average

    Adjusted conversion price
    €0.7333
    Shares after
    2,727,273
    Extra shares issued
    +227,273

  • Narrow-based weighted average

    Adjusted conversion price
    €0.7286
    Shares after
    2,745,098
    Extra shares issued
    +245,098

  • Full ratchet

    Adjusted conversion price
    €0.40
    Shares after
    5,000,000
    Extra shares issued
    +2,500,000
Shares before2,500,000
Shares after2,727,273
Extra shares issued227,273

What the clause costs everyone else

Without the clause66.7%
With it65.7%

Cap table after the adjustment

  • Founders and employees65.7%
  • Protected investor17.9%
  • Down round investor16.4%

  • Founders and employees

    Ownership
    65.7%
    Shares
    10,000,000
    Value
    €4,000,000

  • Protected investor

    Ownership
    17.9%
    Shares
    2,727,273
    Value
    €1,090,909

  • Down round investor

    Ownership
    16.4%
    Shares
    2,500,000
    Value
    €1,000,000

  • Total

    Ownership
    100.0%
    Shares
    15,227,273
    Value
    €6,090,909
How this is calculated
  1. Weighted average: new price = old price × (A + B) ÷ (A + C).
  2. A is the shares outstanding before the new issue, B is what the new money would have bought at the old price, and C is what it actually bought.
  3. Broad-based counts options and convertibles in A; narrow-based does not. A larger A dampens the adjustment, so broad-based is friendlier to founders.
  4. Full ratchet ignores the weighting entirely: the conversion price simply becomes the new price.
  5. The adjustment only ever moves the price down. A round at or above the old price triggers nothing.
What this model leaves out
  • Pay to play and carve-outs are not modelled. A pay to play provision can remove the protection entirely from an investor who does not join the new round, which is common in exactly the down round modelled here.
  • The adjustment only ever moves the conversion price down. A round above the old price triggers nothing.
  • The extra shares dilute everyone holding, the new investor included, because the new round's share count was fixed by its own price.

Common questions

What is anti-dilution protection?
It is a clause that repays an earlier investor when the company later sells shares more cheaply than they paid. It works by lowering the price at which their preferred shares convert into common, which hands them more common shares for the same investment. It protects against price, not against dilution generally: an investor with anti-dilution protection is still diluted by a round priced above what they paid. It only engages in a down round.
What is the difference between full ratchet and weighted average?
Full ratchet reprices the protected investor's entire holding as though they had paid the new lower price, no matter how few shares were sold at it. Weighted average reprices only in proportion to how much cheap stock was actually issued, so a small down round produces a small adjustment. Full ratchet is severe: one share sold at a low price can reprice millions. Weighted average is the market standard and full ratchet is the term to push back on hardest, which is why this tool computes all three at once rather than making you model them separately.
What is the difference between broad-based and narrow-based weighted average?
The difference is which shares are counted in the denominator of the adjustment formula. Broad-based counts everything on a fully diluted basis, including the option pool and outstanding convertibles. Narrow-based counts only the outstanding preferred, or some narrower set. A bigger denominator produces a smaller adjustment, so broad-based is the founder friendly version. The gap is real but often small: on a typical case the two land at EUR 0.7333 and EUR 0.7286 a share, which is why this tool prints four decimal places rather than two.
Who pays for anti-dilution protection?
Everybody who does not have it, which in practice means the founders and the employees. The protected investor receives extra common shares out of nowhere, so the total share count rises and every unprotected holder's percentage falls. The clause does not create value, it moves it, and the direction is always away from the people whose shares came with no protection. The tool reports what the unprotected keep with and without the clause, because that is the number the clause is actually about.
What is a down round?
A down round is a financing priced below the previous round's price per share. It is unpleasant rather than fatal, and it is the event that triggers anti-dilution protection, pay to play provisions and a good deal of renegotiation. What makes it costly for founders is rarely the new money itself but the machinery it sets off in the documents signed two years earlier. Modelling the clause before you sign it is considerably cheaper than discovering it in a down round.
Does anti-dilution protection apply if the company raises at a higher price?
No. Every version of the clause is triggered by an issue at a price below what the protected investor paid, so a round at a higher price does nothing. The investor is diluted by that round like everyone else, in the ordinary way, because their percentage falls while their share count stays the same. The protection exists for one scenario and is inert outside it, which is worth remembering when it is presented as though it were a general safeguard.

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