What is anti-dilution protection?
Anti-dilution protection shields preferred-stock investors against issuances of new equity at a price lower than their original purchase price (a “down round“). Without protection, the investor’s effective ownership and economic position would dilute. The two primary structures are full ratchet (aggressive, rare today outside special situations) and the much more common weighted-average ratchet.
Weighted-average formula
The weighted-average adjustment recalculates the investor’s conversion price using the size of the down round relative to the existing capitalisation. Two variants:
- Broad-based weighted average: NCP = OCP × (A + B) / (A + C), where OCP = original conversion price, A = outstanding common (including options, warrants, convertibles on as-converted basis), B = proceeds-divided-by-OCP shares that would have been issued at OCP, C = actual shares issued. Industry standard; NVCA Model Documents default.
- Narrow-based weighted average: same formula but A counts only outstanding preferred — produces a larger adjustment, more dilutive to founders.
Full ratchet vs. weighted average
- Full ratchet: conversion price drops to the down-round price regardless of round size. Highly punitive to founders; mostly avoided.
- Weighted average (broad-based): proportionate adjustment based on size of down round; founder-fair industry standard.
Typical carve-outs
- Issuances under board-approved option plans (within pre-agreed reserve).
- Shares issued in M&A consideration (board approved).
- Shares issued upon conversion of existing convertibles.
- Strategic partnerships / commercial collaborations (often with cap).
Running the weighted-average formula
Weighted-average anti-dilution adjusts the conversion price by the dilution’s actual weight rather than punishing it fully: new price = old price × (A + B) / (A + C), where A is shares outstanding before the down round, B the shares the new money would buy at the old price, and C the shares actually issued. Broad-based versions count the fully-diluted share base in A (smaller adjustment, market standard); narrow-based count less (sharper adjustment, investor-favourable). Negotiation points hide in definitions: what counts as “shares outstanding” (options? other convertibles?), which issuances are exempt (ESOP, conversions, strategic deals), and pay-to-play conditions on the protection. In Turkish deals the formula lives in the SHA and operationalises through bonus-share allocations or low-priced subscription rights — the implementation mechanics deserve as much drafting care as the algebra.