Anti-dilution ratchets are provisions in investment agreements that protect existing investors from ownership dilution when a company issues new shares at a lower price in future funding rounds.

These clauses are commonly used in venture capital and startup financing to preserve the value of an investor’s original investment during a down round, where new shares are sold below the previous valuation.

Anti-dilution ratchets adjust the conversion price or share ratio of existing preferred shares to reduce the impact of dilution on early investors.

There are two main types of anti-dilution ratchets:

• Full ratchet anti-dilution
• Weighted average anti-dilution

A full ratchet provision adjusts the investor’s conversion price to match the lower share price issued in a future funding round. This provides strong protection for investors but can significantly dilute founders and other shareholders.

Weighted average anti-dilution uses a formula that considers both the new share price and the number of shares issued. This approach is generally viewed as more balanced because it spreads dilution more fairly among shareholders.

Weighted average ratchets may also be classified as:

• Broad-based weighted average
• Narrow-based weighted average

For example, if investors purchased shares at $10 per share and the company later issues shares at $7 per share, the anti-dilution ratchet may adjust the original conversion terms to reduce investor losses from dilution.

Why are Anti-Dilution Ratchets Important?

Anti-dilution ratchets help protect investors from decreases in ownership value during future fundraising rounds. They are an important part of startup investment negotiations because they influence shareholder ownership, company valuation, and future fundraising flexibility.

While these provisions benefit investors, aggressive anti-dilution terms may also impact founders, employees, and future investors by increasing dilution pressure.