Glossary · Shareholder rights & company governance
Anti-Dilution Protection
Anti-dilution protection is a term of convertible preferred stock that lowers its conversion price when the company later issues shares at a lower price, so the preferred holder receives more common shares on conversion.
If a company raises money at a lower price per share than an investor paid, anti-dilution protection compensates that investor by letting its preferred shares convert into more common shares. The extra shares come out of everyone else's percentage, mainly founders and employees. The usual US form only partly compensates the investor; the harshest form, full ratchet, reprices it completely.
Formulas
Broad-based weighted average
- CP2
- the new conversion price of the protected series after the dilutive issue
- CP1
- the conversion price in effect immediately before the dilutive issue
- A
- shares deemed outstanding immediately before the issue: in the broad-based form, all common stock plus all shares issuable on conversion or exercise of outstanding preferred, options and other convertible securities
- B
- the number of shares the total consideration received for the new issue would have bought at CP1 (consideration / CP1)
- C
- the number of new shares actually issued
This is the form and lettering used in the NVCA model certificate of incorporation. A narrow-based version counts fewer shares in A (for example, only outstanding common, or common plus preferred without options), which produces a lower CP2 and more protection. Some documents also include the unallocated option pool in A ("broader-based").
Full ratchet
- Pnew
- price per share of the dilutive issue
Ignores how many shares are issued: selling a single share below CP1 reprices the whole series. Rare in US venture practice outside stressed or structured financings.
Effect on conversion
- OIP
- original issue price of the protected series
- npref
- preferred shares held
The liquidation preference per share is unchanged by an anti-dilution adjustment; only the conversion ratio changes.
When it is triggered
Price-based anti-dilution applies when the company issues new equity (or rights to it) at a price below the protected series' current conversion price. Charters exclude a list of issues, often called exempted securities or carve-outs: shares and options granted under the approved equity plan, conversion shares, shares issued in approved acquisitions, equipment-lease or bank warrants, and other issues approved by a stated majority of preferred. Stock splits and stock dividends are handled by separate structural (proportional) adjustments, which apply to all holders equally and are not price-based protection.
Who bears the cost
The extra conversion shares dilute every holder that does not receive them: common stockholders, option holders, unprotected or less protected series and, unless its price is set after the adjustment, the new investor. New investors therefore usually insist that the price of the new round be computed on a share count that already includes the anti-dilution adjustment, which lowers the price, which increases the adjustment. The two are solved together.
Market practice
Broad-based weighted-average protection is the common form in US venture financings; the National Venture Capital Association (NVCA) model certificate of incorporation offers it and a full ratchet as alternative clauses. Full ratchets appear mainly in stressed financings, bridge instruments or as time-limited protection. In a down round the protected holders are often asked to waive the adjustment, in whole or in part, to keep the new round financeable; a stated majority of the preferred can usually waive for the whole series. Pay-to-play provisions can make the protection conditional on the holder investing its pro rata share in the new round.
Anti-dilution versus pro rata rights
Anti-dilution protection changes the price at which existing preferred converts when shares are sold more cheaply. Pro rata rights let a holder buy new shares to keep its percentage. In an up round, price-based anti-dilution does nothing; the holder's percentage is protected only if it buys its pro rata share.
Why LPs and valuers care
Anti-dilution adjustments change ownership after a down round, which changes the as-converted share used in exit liquidation preference waterfalls and in fair value allocations. Repeated adjustments are also a sign of a company financed through declining prices, which shifts value from founders and employees to investors and can affect retention.
Worked examples
Illustrative down round under broad-based protection
Series A investors hold 2,000,000 preferred shares bought at $2.00 (CP1 = $2.00). Before the new round the company has 10,000,000 fully diluted shares: 6,000,000 common, 2,000,000 options and the 2,000,000 Series A. It then sells 2,000,000 new shares at $1.00, raising $2m. Under broad-based weighted-average protection, A = 10,000,000; B = $2m / $2.00 = 1,000,000; C = 2,000,000. CP2 = $2.00 × 11,000,000 / 12,000,000 = $1.8333, so Series A converts into 2,181,818 common shares, 181,818 more than before.
Narrow-based and full ratchet on the same round
A narrow-based clause that leaves the 2,000,000 options out of A (A = 8,000,000) gives CP2 = $2.00 × 9,000,000 / 10,000,000 = $1.80 and 2,222,222 shares. A full ratchet resets CP2 to the $1.00 issue price, giving 4,000,000 shares. With no adjustment Series A would own 16.7% of the 12,000,000 shares after the round; with broad-based protection 17.9%, narrow-based 18.2% and full ratchet 28.6%. The holders of the other 8,000,000 shares fall from 66.7% to 65.7%, 65.5% and 57.1% respectively.
Examples are illustrative; figures are not market data.
Not the same as
- Pro Rata Rights: Pro rata rights protect percentage ownership by letting a holder buy into new rounds; anti-dilution changes the conversion price only when new shares are sold below it.
- Dilution: Dilution is any fall in percentage ownership from new issuance; anti-dilution protection addresses only issuance below the protected price.
Common mistakes
- Believing anti-dilution protects against all dilution. In an up round it does nothing.
- Computing B at the new price instead of at CP1. B is the number of shares the new money would have bought at the old conversion price.
- Assuming "broad-based" means the same share count in every charter. The definition of A varies and changes the result.
- Forgetting that the liquidation preference per share does not change; only the conversion ratio does.
- Ignoring the circularity between the adjustment and the new round's price.
Edge cases
- Multiple closings of the same round: each closing below CP1 can trigger a further adjustment unless the charter treats the round as one issue.
- Issuances of warrants or convertibles count at their total consideration (price paid plus exercise or conversion price), so B and C use deemed amounts.
- If the protected series has already converted to common, there is nothing left to adjust.
Questions
Does anti-dilution protection apply in an up round?
No. Price-based anti-dilution applies only when shares are issued below the protected series' conversion price.
What is the difference between broad-based and narrow-based weighted average?
The size of A, the share base in the formula. Broad-based counts options and convertibles as outstanding, which spreads the effect over more shares and gives a smaller adjustment; narrow-based counts fewer shares and gives more protection.
Sources
- NVCA Model Legal Documents. National Venture Capital Association, NVCA, Certificate of Incorporation, Stock Purchase Agreement, Investors' Rights Agreement updated October 2025; Voting Agreement June 2026; ROFR and Co-Sale April 2026; Management Rights Letter and Indemnification Agreement July 2020. Status: Current (checked 2026-10-01). Certificate of Incorporation, adjustment of conversion price upon issuance of additional shares (CP2 = CP1 x (A + B) / (A + C)); exempted securities; waiver — supports: Broad-based weighted-average formula and variable definitions, carve-outs, waiver by required preferred majority
Related terms
7 termsReferenced by
1 termConcept record
- Concept ID
- ALTSS-VC-017
- Classification
- Shareholder rights & company governance
- Topics
- Venture capital & startups
- Version
- 2.0.0
- Last reviewed
- Structured data
- JSON