Importance of Anti-Dilution Provisions in Venture Financing Deals

The primary purpose of anti-dilution provisions is to protect investors from the adverse impact experienced when a company issues new securities (whether it be shares of preference stock, common stock or securities convertible, exercisable or exchangeable for shares of preferred or common stock) at a price that is lower than that paid by such investors. Anti-dilution protection and the liquidation preference are two important provisions that distinguish preferred stock from common stock.


There are two principle formulae to grant protection against anti-dilution: full ratchet and weighted average formulae. In each case, the anti-dilution protection can be effected by an adjustment to the conversion ratio of the investor’s share of preferred stock into shares of common stock (or sometime by the issuance of additional shares of capital stock to the investors).

The full ratchet formula is a more aggressive form of anti-dilution protection than weighted average formula and provides the most protection to the investors, but has the greatest adverse impact on the company, founders and management. The purpose of a full ratchet formula is simple – to place the investor in the same position it would have been had it originally invested in the company at the lower price per share being paid by the new investors in the subsequent round of financing, that is, the new conversion price for converting the investor’s share of preferred stock into shares of common stock would equal the lower price per share being paid by the new investors.

Weighted average formula is considered more equitable and takes into account the number of shares already issued plus the number of new shares being issued at the lower price. The weighted average formula determines the adjustment to be made to an existing investor’s stockholding based on the size of new offering and the lower price at which the new shares are to be issued to the new investors. Under the weighted average formula, the new conversion price of the investor’s share of preferred stock into shares of common stock can be calculated using the following formula:

new conversion Price = old conversion price x common stock equivalents prior to issuance + old conversion price (new consideration)/ common stock equivalents prior to issuance + new common stock equivalents


There are two main variations of the weighted average formula, namely, broad based and narrow based. Broad based weighted average includes a wider range of shares and other securities (such as warrants, options and other convertible securities) in the calculation and therefore the adjustment required to the existing investors’ stockholding is lower. Accordingly, it is less onerous on the company and not as dilutive on the founders, management and existing investors. Narrow based weighted average formula, includes a less number of shares and securities (generally may not include warrants, options and other convertible securities) in the calculation and therefore the adjustment required to the existing investors stockholding is higher and is therefore more burdensome on the company, founders and management.