Deal Terms
What is anti-dilution protection?
Quick Answer
Anti-dilution protection adjusts an investor's conversion price downward if the company raises a future round at a lower valuation (down round). The standard type is broad-based weighted average, which partially protects investors while limiting founder dilution.
Detailed Answer
Anti-dilution provisions protect investors from losing value when a company raises money at a lower valuation than their original investment (a down round).
Two main types:
**1. Broad-Based Weighted Average (Standard)** Adjusts the conversion price using a formula that considers both the size of the down round and the total shares outstanding. This is the market standard and is generally fair to both sides.
Formula: New Price = Old Price × [(Old Shares + New Money/Old Price) ÷ (Old Shares + New Shares Issued)]
**2. Full Ratchet (Aggressive)** Reduces the investor's price to match the new lower price exactly, regardless of the round size. This can be extremely dilutive to founders.
Example — $10M invested at $10/share (1M shares) with a down round at $5/share: - Full ratchet: Investor's price resets to $5, giving them 2M shares (double) - Weighted average: Price adjusts partially, maybe to $7, giving them ~1.43M shares
Founder guidance: - Always negotiate for broad-based weighted average - Resist full ratchet — it's a sign of a predatory term - Pay-to-play provisions can offset anti-dilution (investors must participate in the down round to keep their protection)
Related Questions
What is a SAFE (Simple Agreement for Future Equity)?
A SAFE is an investment contract created by Y Combinator where an investor provides capital to a startup in exchange for the right to receive equity in a future priced round, with terms like a valuation cap and/or discount rate.
What is a term sheet?
A term sheet is a non-binding document that outlines the key terms and conditions of a proposed investment, including valuation, investment amount, board seats, liquidation preferences, and protective provisions.
What is a liquidation preference?
A liquidation preference gives preferred shareholders (investors) the right to receive their investment back before common shareholders in an exit. The standard is 1x non-participating, meaning investors get back their investment amount or convert to common stock — whichever is higher.
What is a convertible note?
A convertible note is a short-term debt instrument that converts into equity at the next priced round, typically with a valuation cap, discount rate, interest rate (2-8%), and maturity date (12-24 months).
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