Anti-dilution clauses explained: weighted-average vs full-ratchet, and why it matters

Anti-dilution protection is a clause every term sheet has. It only activates if the company raises a future round at a lower price per share than the current round. Founders sign it without much thought because it feels theoretical — surely we won't raise a down round, right? Most won't. Many do, especially when market sentiment turns. And when it triggers, the difference between the two forms of anti-dilution is the difference between annoying and catastrophic.

Broad-based weighted-average. This is the founder-friendly form. The investor's conversion price gets adjusted based on a formula that weighs the size of the new dilutive issuance against the existing share base. The bigger the down round, the bigger the adjustment. The smaller, the smaller. In a 20% down round of typical size, the investor's effective ownership might bump up by half a percent — meaningful but not catastrophic.

Narrow-based weighted-average. Same formula, different denominator. Excludes common stock and options from the share count. Adjusts more aggressively than broad-based. Sits in the middle of the spectrum.

Full-ratchet. The investor-aggressive form. If you raise the next round at a lower price per share, the investor's conversion price is reset all the way down to that new price — regardless of how big or small the down round is. The size of the new issuance is irrelevant. A tiny down round triggers the same adjustment as a massive one. Effect: investors get a lot more shares, founders are diluted disproportionately, and the cap-table arithmetic gets ugly fast.

Here's the math on a real-ish example. You raised $10M at $40M post (25% to the investor) with a 1x non-participating preference and full-ratchet anti-dilution. Eighteen months later, market sentiment cooled and you raise a $5M bridge at $20M post. Without anti-dilution, the bridge investor takes 25%. With full-ratchet, the previous investor's conversion price halves; their pre-bridge ownership effectively doubles. Founder dilution: roughly double what the cap-table on the bridge term sheet shows. The bridge investor's deal is still the same. The previous investor's deal is much better.

What to negotiate for: broad-based weighted-average, with a carve-out for issuances under a small-issuance threshold and for ESOP top-ups. Most institutional VCs accept this without much push-back. Crossover or growth funds occasionally push for narrow-based or full-ratchet — fight that, every time.

What to watch: anti-dilution can be paired with a 'pay-to-play' clause that forces existing investors to participate in the down round or lose their preferred preferences. This is founder-friendly and worth asking for if you can.

One more thing. Anti-dilution is reset on every subsequent up round — once you raise above the protected price, the protection drops away. So the practical risk window is the period between the round being signed and the next up round closing. In a healthy company, that's twelve to eighteen months. In a stressed one, it's the year the clause matters most.