Anti-Dilution Protection
AdvancedAnti-dilution protection is a provision that protects investors, typically holders of preferred shares in venture capital deals, if a company later issues shares at a lower price than they paid, by adjusting the price at which their shares convert into ordinary shares.
If a company raises money at a lower valuation than in an earlier round, a down round, earlier investors' stakes become worth less. Anti-dilution protection gives them additional shares to offset part or all of this loss, at the expense of other shareholders, usually founders and employees.
There are two main types. Full ratchet protection resets the investor's conversion price to the new, lower price. Weighted-average protection, which is more common and more moderate, adjusts the price based on both the new price and the number of new shares issued.
For example, investors paid 2.00 per share. The company later issues 5,000,000 new shares at 1.00, when 10,000,000 shares were already outstanding. Under full ratchet, the earlier investors' conversion price falls to 1.00, doubling their shares. Under a broad-based weighted-average formula, it falls to about 1.67.
Anti-dilution protection does not prevent dilution from new shares issued at higher prices, which is normal in growing companies. Founders should understand these terms, since they can significantly affect ownership after a down round.
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