Anti-dilution

Northwind’s Series A investor paid $5.00 a share. Two years later, growth is slower than the plan, and the best offer of new money is at $2.50 a share. Ada and Ben know that the new shares dilute them. Many founders do not know about the second dilution: the Series A also gets more shares. This lesson shows how many, and why one clause in the term sheet decides the answer.

Down rounds and the conversion price

A down round sells shares at a lower price for each share than the round before it. In Q2 2026, 12.1% of the deals that Cooley tracked were down rounds.

Preferred stock converts into common stock at its conversion price. At first, the conversion price is the same as the original issue price, so each preferred share converts into one common share:

Conversion ratio
  = original issue price
    ÷ conversion price
  = $5.00 ÷ $5.00
  = 1

Anti-dilution protection lowers the conversion price after a down round. The company does not issue new preferred shares. Instead, the conversion ratio increases, and each preferred share converts into more common shares.

This lesson uses one cap table before the down round:

• Founders: 7,000,000 common shares
• Employees: 1,000,000 outstanding options
• Series A: 2,000,000 preferred shares at $5.00, $10M in total
• Total: 10,000,000 shares, fully diluted.

The down round is a Series B that raises $5M at $2.50, so it issues 2,000,000 new shares. With no protection, the company has 12,000,000 shares after the round. The founders own 58.33%, and the Series A owns 16.67%.

Why investors ask for protection

The Series A paid $5.00 because the two sides agreed on a valuation at that time. A down round at $2.50 says that the price was too high. Someone pays for that mistake. Without protection, every holder loses value in proportion to what it owns. With protection, the term sheet moves part of the loss from the protected investor to the holders who have no protection.

The method decides how big that part is. Full ratchet moves the full loss to the other holders, as if the investor paid the new price from the start. Weighted average moves only a part, in proportion to the size of the down round. That is why founders accept weighted average, and why they reject full ratchet.

Full ratchet: the new price, whatever the size

Full ratchet is the strongest protection. The conversion price decreases all the way to the new, lower price:

CP2    = new price = $2.50
Ratio  = $5.00 ÷ $2.50 = 2
Shares = 2,000,000 × 2
       = 4,000,000 common shares

The Series A now holds 4,000,000 of 14,000,000 shares, which is 28.57%. The founders fall to 50%. The ratchet formula does not use the size of the new round. A $500K round at $2.50 gives the Series A the same 2,000,000 extra shares as a $5M round. For this reason, lawyers and founders call full ratchet punitive. The NVCA removed it from its model term sheet in 2020, and it stays only as an option in the model charter.

Broad-based weighted average

The standard method moves the conversion price only part of the way down. The size of the down round, compared with the size of the company, sets how far. This is the NVCA formula for broad-based weighted average:

CP2 = CP1 × (A + B) ÷ (A + C)

The letters in the formula:

• CP1 is the conversion price just before the new round, here $5.00.
• CP2 is the conversion price just after the new round.
• A is the shares outstanding before the round: common, preferred as converted, and outstanding options. Here, A is 10,000,000.
• B is the number of shares that the new money buys at the old price, CP1.
• C is the number of shares that the round actually issues.

If the new price is the same as CP1, then B is the same as C, and the price does not change. The lower the new price, the more C is larger than B, and the more the price decreases.

Predict first

With broad-based weighted average, what is the new Series A conversion price after the $5M round at $2.50?

Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.

Your guessSave my guess

Worked example · step 1 of 5

Broad-based weighted average, step by step

1. 1

   Shares that the round issues (C)

   Divide the new money by the new price.

   C = $5,000,000 ÷ $2.50
     = 2,000,000

Show step 2Show all steps

The price moved C ÷ (A + C) of the way from $5.00 to $2.50. Here that is 2,000,000 ÷ 12,000,000, one sixth. This fraction is the part of the company that the down round sells. A small down round moves the price a little, and a large down round moves it far.

Narrow-based: a smaller A

The narrow-based weighted average formula uses a smaller A. It counts fewer of the current shares, usually without the options. With a smaller A, each new share has more weight, so the adjustment is a little larger:

The two weighted averages are close. The large gap is between the weighted averages and the ratchet.

The size of the round

Now make the down round small: $500K at the same $2.50 price. C is 200,000, and B is 100,000:

Broad-based:
  CP2 = $5.00 × 10,100,000
              ÷ 10,200,000
      = $4.951
  Extra shares = 19,802

Full ratchet:
  CP2 = $2.50
  Extra shares = 2,000,000

With full ratchet, a small round at a low price doubles the share count of the Series A. Move the two sliders in the widget, and compare the bars for the four methods.

Calculator

Anti-dilution in a down round

The Series A paid $5.00 for each of its 2,000,000 shares. A new round sells shares at a lower price. Compare the protection methods.

Price per share in the new round

$2.50

Money raised in the new round

$5M

Series A anti-dilution

NoneBroadNarrowRatchet

Conversion price

$4.5833

Was $5.00

Converts into

2,181,818

+181,818 shares

Founders own

57.46%

58.33% with no protection

Series A owns

17.91%

New investors own 16.42%

Series A common shares after the round, by method

No protection

2,000,000

Broad-based

2,181,818

Narrow-based

2,200,000

Full ratchet

4,000,000

Ownership after the round: broad-based

• Founders
• Employee options
• Series A
• New investors

The new round raises $5M at $2.50, 50% of the Series A price. The weighted average moves the Series A price to $4.5833, only part of the way. The round issues 2,000,000 shares, compared with 10,000,000 before the round (all shares and options).

Here, full ratchet adds 2,000,000 shares and broad-based adds 181,818. Change the money raised: the broad-based number moves, but the ratchet number stays the same.

Who pays for the extra shares

Anti-dilution protects only the investors who have it. The common holders pay for it. The new shares dilute them one time, and the extra conversion shares dilute them a second time:

The new Series B investors also lose a little, because the extra Series A shares dilute them too. The clause also lists standard exceptions. Shares for employee options, conversions of preferred stock, stock splits, and other issues that the board approves do not start an adjustment.

How to read and negotiate the clause

Most term sheets use the standard text, but read three details:

• The method. Ask for broad-based weighted average. Treat full ratchet as a red flag.
• The base. Make sure that A counts the outstanding options. A narrow base gives the investor a larger adjustment.
• The exceptions. Make sure that the list includes shares for employee options, conversions, and stock splits. Without these exceptions, a normal option grant at a low price can start an adjustment.

Does anti-dilution apply in an up round?

No. The adjustment applies only when the company issues new shares at a price that is lower than the conversion price. In an up round, the new price is higher than CP1, so B is larger than C. The clause applies only to a lower price, so nothing changes. The protection works in one direction only.

What is market in 2025-2026

A down round can bring other hard terms too. In 2025, 42% of the Series B and later down rounds in Wilson Sonsini deals had pay-to-play. This term makes current investors buy their part of the new round, or lose rights. The lesson on down rounds and recaps explains it.

Practice

Work it out

A Series A has a conversion price of $4.00. Before a down round, A = 20,000,000 shares. The company raises $4M at $2.00 a share. With broad-based weighted average, what is the new conversion price?

Your answerCheck

Work it out

An investor holds 1,000,000 shares of that Series A, bought at $4.00. After the adjustment to $3.8182, how many common shares does the investor convert into?

Your answerCheck

Quiz · question 1 of 5

Test what you learned

In CP2 = CP1 × (A + B) ÷ (A + C), what is B?

• AThe shares outstanding before the round
• BThe new money divided by the old conversion price, CP1
• CThe new price for each share
• DThe number of new shares that the company actually issues