What is an anti-dilution agreement?
An anti-dilution agreement: more commonly called an anti-dilution provision embedded in a preferred-stock charter: protects an existing investor’s economic interest from being diminished when the company issues new equity at a lower price (a down round). The two main mechanics are broad-based weighted average (the market standard) and full-ratchet (more investor-favourable).
Weighted-average anti-dilution adjusts the conversion ratio of preferred stock based on a formula reflecting both the down-round price and the size of the new issuance. Full-ratchet anti-dilution simply resets the conversion price to the down-round price, regardless of issuance size, and is rare outside distressed scenarios.
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Full-ratchet vs weighted-average, and what it costs founders
Anti-dilution clauses come in two main flavours, and the difference is dramatic. A full-ratchet provision reprices the investor’s earlier shares as if they had paid the new, lower price, which transfers a large amount of value away from founders in a down round. A weighted-average provision: far more common and more balanced: only adjusts the conversion price in proportion to how much new, cheaper stock is issued relative to the existing base. Well-drafted clauses also carve out events that should not trigger adjustment, such as shares issued under an approved option pool, on conversion of existing convertibles, or in connection with M&A. Founders should model the impact of each formula on a realistic down-round before agreeing, because the wording chosen at the term-sheet stage can quietly decide who controls the company after a tough financing.
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