Why does Anti-Dilution Protection matter?
This term matters most exactly when a company can least afford it, during a down round, because it determines how much of the pain of a lower valuation lands on founders and common shareholders versus being partly absorbed by repricing an earlier investor's shares in their favor. Whether the mechanism is full ratchet or weighted average makes a large practical difference in how severe that repricing is, and founders often do not feel its weight until negotiating a down round with it already locked into an earlier round's documents.
What does Anti-Dilution Protection look like in practice?
Suppose an investor bought shares at $2.00 each in an earlier round with weighted-average anti-dilution, and the company later raises at $1.00 per share. Weighted-average anti-dilution adjusts that investor's effective price down partway toward $1.00, factoring in how many new shares are being issued relative to the existing base, a meaningful but proportionate correction. Full-ratchet anti-dilution would instead reprice all of that investor's shares straight down to $1.00 regardless of how many new shares were actually issued, dramatically more dilutive to everyone else on the cap table.
What are the common mistakes with Anti-Dilution Protection?
- Accepting full-ratchet anti-dilution in an early round without understanding how disproportionately punishing it becomes for founders in a future down round, compared to the much more common weighted-average standard.
- Not modeling what a future down round would actually do to founder ownership given the anti-dilution terms already in the cap table, before that scenario becomes real.
- Assuming anti-dilution protection only affects the investor who holds it, when its repricing effect dilutes everyone else on the cap table who does not hold the same protection.
- Treating anti-dilution as boilerplate because it never seems to matter until the one round where it matters enormously.
Related concepts
- Down RoundA financing round priced at a lower valuation than the company's previous round, which dilutes existing shareholders more heavily than a flat or up round would.
- DilutionThe reduction in each existing shareholder's percentage ownership that happens whenever a company issues new shares, whether from a new financing round or a new option pool.
- Liquidation PreferenceA term giving preferred shareholders (investors) the right to be paid a specified multiple of their investment back before common shareholders (founders and employees) receive anything from a sale or liquidation.
- Protective ProvisionsA list of specific company actions (raising more money, selling the company, changing the size of the option pool, taking on debt above a threshold) that require the separate approval of preferred shareholders (investors) as a class, beyond ordinary board or common-stockholder approval.