Anti-Dilution Provisions: Full Ratchet vs. Weighted Average Explained

Imagine building a company for three years, owning 60% of the equity, then raising a down round and discovering you now own 25%. Same company, same value creation, but your ownership just got slashed by more than half. The culprit? A full ratchet anti-dilution provision.

Anti-dilution provisions are one of the most technical—and consequential—terms in venture capital. They determine what happens to investor ownership when a company raises money at a lower valuation than previous rounds (a "down round"). While they're designed to protect investors from dilution, their structure can mean the difference between fair protection and devastating founder dilution.

In this guide, we'll break down exactly how anti-dilution provisions work, the difference between full ratchet and weighted average formulas, and how these terms can be used to protect or harm both founders and investors.

What Are Anti-Dilution Provisions?

Anti-dilution provisions protect investors from ownership dilution when a company raises capital at a lower price per share than previous rounds. Without these provisions, early investors would see their ownership percentage shrink significantly in down rounds.

Here's the basic problem they solve: Investor A buys 20% of a company at $10 per share. A year later, the company struggles and raises a new round at $5 per share. New investors get twice as many shares for their money. Without anti-dilution protection, Investor A's ownership gets diluted substantially.

Anti-dilution provisions allow earlier investors to receive additional shares (for free) to maintain their ownership percentage or reduce the impact of the dilution. The question is: how many additional shares, and under what formula?

The Three Types of Anti-Dilution Protection

1. Full Ratchet (Most Investor-Friendly, Harshest for Founders)

Full ratchet anti-dilution is the nuclear option. It reprices the investor's original shares as if they had invested at the new, lower price per share. The investor receives enough additional shares to make their effective purchase price equal to the down round price.

Example:

• Series A investor buys 2 million shares at $5/share = $10M investment for 20% ownership
• Company later raises Series B at $2.50/share (50% down round)
• With full ratchet: Series A investor's shares are repriced to $2.50/share
• $10M ÷ $2.50 = 4 million shares
• Series A investor receives 2 million additional shares for free
• Investor ownership increases from 20% to ~33% (depending on cap table)

The critical detail: the size of the down round doesn't matter. Whether the company raises $500K or $50M at the lower price, the full ratchet reprices all previous shares. This creates extreme dilution for founders and employees, even if the down round is small.

2. Broad-Based Weighted Average (Most Common, Balanced)

Weighted average anti-dilution adjusts the conversion price based on a formula that considers both the size of the down round and the magnitude of the valuation decrease. It's more mathematical but far more balanced.

The formula:

NCP = OCP × [(A + B) ÷ (A + C)] Where: NCP = New Conversion Price OCP = Old Conversion Price A = Total shares outstanding before the new round B = Total consideration received if shares were sold at old conversion price C = Total consideration actually received in the new round

This formula sounds complex but results in a fair middle ground: investors receive some protection, but the adjustment is proportional to the size and severity of the down round.

Same example as above:

• Series A: $10M for 2M shares at $5/share, 20% ownership, 10M total shares outstanding
• Series B: Raising $5M at $2.50/share
• Formula: NCP = $5 × [(10M + $10M) ÷ (10M + $5M)]
• NCP = $5 × [20M ÷ 15M] = $5 × 1.33 = $6.67... wait, that's not right.

Let me recalculate properly:

• A = 10M shares outstanding
• B = Number of shares that could be bought at old price: $5M ÷ $5 = 1M shares
• C = Number of shares actually issued: $5M ÷ $2.50 = 2M shares
• NCP = $5 × [(10M + 1M) ÷ (10M + 2M)]
• NCP = $5 × [11M ÷ 12M] = $5 × 0.917 = $4.58
• New shares for Series A: $10M ÷ $4.58 = 2.18M shares (vs. original 2M)
• Series A investor receives 180,000 additional shares (vs. 2M under full ratchet)

Under weighted average, the Series A investor receives meaningful protection (180K additional shares), but not the nuclear dilution of full ratchet (2M additional shares). Founders are diluted, but not devastated.

3. Narrow-Based Weighted Average (Less Common)

Narrow-based weighted average uses the same formula as broad-based, but "A" (shares outstanding) only includes common stock and preferred stock, NOT the unissued option pool. This results in slightly more investor protection than broad-based weighted average, but less than full ratchet.

In practice, broad-based weighted average has become the standard, and narrow-based is rarely seen except in highly negotiated or distressed situations.

How Anti-Dilution Provisions Can Be Used Against Founders

Anti-dilution provisions are designed to protect investors, but in their most aggressive forms, they can create catastrophic dilution for founders and employees.

Scenario 1: Full Ratchet in a Down Round

A founder owns 60% of a company after a Series A round. The company raised $10M at $50M post-money ($5/share, 10M shares outstanding). Founder owns 6M shares.

Two years later, the company struggles and needs capital. They raise a $3M Series B at a $15M post-money valuation ($1/share), a 70% down round. The Series A investors have full ratchet anti-dilution.

What happens:

• Series A investors originally paid $5/share for 2M shares
• Full ratchet reprices their shares to $1/share
• $10M ÷ $1 = 10M shares
• Series A receives 8M additional shares for free
• New cap table:

The founder went from 60% ownership to 25% ownership overnight. Series A investors went from 20% to 42%. The founder effectively lost 35 percentage points of ownership, which in a future $100M exit is $35M in value.

This is why full ratchet is called the "death spiral provision." It punishes founders so severely that it can destroy incentives to continue building the company.

Scenario 2: "Walking Dead" Company with Full Ratchet

A company with full ratchet anti-dilution faces a difficult situation: they need capital, but raising a down round will trigger massive dilution. Many founders in this situation choose to:

• Avoid raising capital entirely (starving the business)
• Raise at the same or higher valuation even if not justified (creating a "zombie" valuation)
• Sell the company prematurely at a lower price to avoid the dilution

All three options are value-destructive. The company becomes a "walking dead" startup—not quite dead, but unable to access capital without catastrophic dilution.

Why It Matters

Full ratchet anti-dilution creates a misalignment of incentives. Investors are protected, but founders are penalized so harshly that they may abandon the company, refuse to raise needed capital, or make irrational strategic decisions. Ironically, this reduces the probability of investor success.

How Anti-Dilution Provisions Can Be Used Against VCs

While anti-dilution provisions protect investors, weak or absent protection can significantly harm investor returns in down rounds.

Scenario 1: No Anti-Dilution in a Down Round

A VC invests $10M at $50M post-money for 20% ownership. Due to poor negotiation or founder leverage, the deal includes no anti-dilution protection.

Two years later, the company raises $10M at a $25M post-money valuation (50% down round).

Cap table impact:

• Before Series B: VC owns 20% of 10M shares = 2M shares
• Series B: New investors receive 40% of the company (10M new shares issued)
• After Series B: VC owns 2M of 20M total shares = 10% ownership

The VC's ownership dropped from 20% to 10% due to the down round. In a future $100M exit:

• With 20% ownership: $20M proceeds (2x return)
• With 10% ownership: $10M proceeds (1x return)
• Lost value: $10M

That $10M difference matters enormously for fund performance. In a portfolio of 20 companies, turning a 2x winner into a 1x breakeven investment can drop overall fund returns by 0.5x or more.

Scenario 2: Narrow-Based Instead of Broad-Based Weighted Average

A VC negotiates narrow-based weighted average anti-dilution instead of broad-based. In a down round, the difference is:

• Broad-based: Calculation includes 20% option pool (more shares in denominator)
• Narrow-based: Calculation excludes option pool (fewer shares in denominator)

In a $50M post-money company with 10M shares and a 2M share option pool, raising $5M at a 50% down:

• Broad-based weighted average: VC receives ~180K additional shares
• Narrow-based weighted average: VC receives ~220K additional shares
• Difference: 40K shares, worth $400K-$1M depending on exit scenario

Over a portfolio of investments, these "small" differences compound into material underperformance.

Why It Matters

VCs who fail to negotiate anti-dilution protection leave significant value on the table in down-round scenarios. While no investor expects down rounds, they happen in 10-20% of venture investments. Protecting downside in those scenarios is critical for fund returns, particularly for funds targeting 2.5-3x net returns where every basis point matters.

Current Market Standards (2024-2025 Data)

According to Cooley's Q2 2024 Venture Financing Report and Carta's 2025 market data:

• 98% of deals include anti-dilution provisions (it's now considered standard)
• 85% use broad-based weighted average (the market standard)
• 10% use narrow-based weighted average (typically in competitive or down-round scenarios)
• 5% use full ratchet (almost exclusively in distressed financings or highly unfavorable situations)
• Down rounds: Represented 15% of all financings in Q1 2024 (up from 8% in 2021), making anti-dilution provisions increasingly relevant

The market has converged on broad-based weighted average as the fair middle ground. Full ratchet is now widely recognized as overly punitive and value-destructive except in extreme circumstances.

Carve-Outs and Exceptions

Most anti-dilution provisions include carve-outs for specific scenarios where the company issues shares at a lower price but shouldn't trigger anti-dilution:

• Stock splits and dividends: Mechanical changes to share structure
• Options and employee grants: Shares issued under approved option plans
• Convertible note conversions: Notes converting at previously agreed prices
• Strategic partner issuances: Shares issued to partners as part of commercial agreements
• Acquisition consideration: Shares issued to acquire another company

These carve-outs prevent anti-dilution from triggering in routine corporate actions.

Pay-to-Play and Anti-Dilution

Some term sheets include "pay-to-play" provisions that eliminate anti-dilution protection for investors who don't participate in future rounds. This creates an incentive for early investors to continue supporting the company.

Under pay-to-play, if an investor doesn't participate in a down round:

• Their anti-dilution protection is eliminated
• They suffer full dilution alongside founders
• In some cases, their preferred stock converts to common (losing liquidation preferences)

Pay-to-play provisions are controversial but are becoming more common in down-round scenarios.

Key Takeaways

For Founders:

• Broad-based weighted average is the standard. Refuse full ratchet except in truly desperate situations.
• Model the math. Build a scenario showing what happens to your ownership in a 25%, 50%, and 75% down round.
• Carve-outs matter. Ensure option grants, strategic issuances, and acquisition shares don't trigger anti-dilution.
• Down rounds happen. Even great companies sometimes need capital at lower valuations. Anti-dilution structure can make the difference between survivable dilution and catastrophic loss of control.

For VCs:

• Always include anti-dilution. It's standard and protects your fund returns in adverse scenarios.
• Broad-based weighted average is fair. It balances investor protection with founder incentive alignment.
• Full ratchet is usually counterproductive. It creates such severe dilution that founders may abandon the company, making your investment worthless.
• Understand the formulas. Know how to calculate weighted average adjustments so you can model scenarios accurately.

Why This Matters

Anti-dilution provisions are one of those terms that seem theoretical until they're not. For most companies, they never trigger. But for the 15% of companies that raise down rounds, anti-dilution structure determines whether dilution is manageable or catastrophic.

For founders, accepting full ratchet to get a deal done can backfire spectacularly if the company later needs capital at a lower price. For investors, failing to negotiate anti-dilution protection can turn winning investments into mediocre returns.

Understanding the mechanics—full ratchet vs. weighted average, broad-based vs. narrow-based, carve-outs and pay-to-play—isn't just technical knowledge. It's the difference between building a fair, sustainable capital structure and creating a ticking time bomb that explodes in down markets.

In venture capital, the details aren't just important. They're worth millions.