Anti-Dilution

Anti-dilution provisions protect investors from economic dilution if a company raises a future round at a lower valuation (a down round). The two common types are "full ratchet" and "weighted average." Full ratchet adjusts the investor's conversion price to match the lower round's price, regardless of how much is raised. Weighted average takes into account both the lower price and the amount raised, resulting in a more moderate adjustment.

Broad-based weighted average anti-dilution is the current market standard and is considered fair to both sides. It protects investors from significant value destruction while limiting the extra dilution imposed on founders. Full ratchet is aggressive and rare in healthy markets, but may appear in down rounds or in deals where investors have significant leverage.

Founders need to understand anti-dilution because it can dramatically affect their ownership in a down round scenario. In extreme cases, full ratchet anti-dilution can nearly wipe out founder equity. This is why negotiating the type of anti-dilution protection is one of the most important elements of a term sheet, even though it only matters in a downside scenario.