Anti-Dilution Calculator.

Why do anti-dilution clauses exist?

Anti-dilution clauses (also referred to as down-round protection) are meant to protect the existing investor if a later round takes place at a lower issue price per share. Without protection, the existing investor's economic position worsens, to a greater or lesser extent depending on the severity of the down round. The clause reallocates part of that risk to other stakeholders.

Percentage dilution vs. economic dilution

Percentage dilution means that an existing shareholder's percentage interest in the company decreases, for example from 20% to 15%. That happens in every financing round and, apart from the effect on voting rights, is not a problem so long as the value per share remains at least constant.

Economic dilution is the real risk. It arises where new shares are issued at a lower price per share than in the previous round. The decisive figure is the issue price per share, not the valuation: if shares have been issued since the last round (for example through an ESOP top-up or conversions), even a pre-money valuation equal to or above the last post-money valuation can result in a lower price per share. Example: with a last post-money valuation of 10 million € and 1 million shares, the price was 10.00 € per share; after 100,000 new ESOP shares, the same pre-money valuation of 10 million € gives only 9.09 € per share. In that case, the existing investor paid a higher price than the current market value. Anti-dilution clauses address exactly that scenario, not percentage dilution in up rounds.

The model fixes the issue price of the round: pre-money valuation divided by the current fully diluted shares. At that price, the new investor receives shares for its investment. The protected existing investor position is derived from the existing investor's original investment and the pre-money valuation of that earlier round; ESOP/convertibles are included as a percentage of current fully diluted shares. The model assumes that no further shares have been issued since the earlier round; within the model, the price comparison therefore corresponds to comparing the new pre-money valuation with the old post-money valuation. The anti-dilution adjustment shares are added to the shares of the round and dilute everyone, including the new investor; its ownership is therefore below investment divided by post-money valuation. If the new investor negotiates a fixed post-money ownership, the adjustment shares are included in the pre-money capitalisation: the issue price falls, and the dilution from the adjustment shares is borne by the existing shareholders. How this point has been negotiated is, in practice, often visible in the cap table model rather than in a standalone contractual clause.

Full ratchet vs. weighted average

Full ratchet is the most aggressive variant. The original price paid by the protected investor is reduced in full to the price of the down round. Economically, the model treats the investor as if that investor had invested at the lower price from the outset (full repricing). This gives strong protection, but it will usually dilute founders the most.

Full ratchet is often criticised as disproportionate because full repricing applies even where the down round is relatively small and the actual dilution would otherwise be limited. In that situation, the effect can be out of proportion to the trigger event. The opposing argument is that the original price was simply not validated by the market and the investor specifically negotiated protection for that case.

Weighted average is the milder approach. Here, the original price is not pulled all the way down to the new price; instead, it is adjusted by formula. The decisive factor is the size of the new round relative to the company's existing capital structure. That is why weighted average is usually the market standard.

Broad-based vs. narrow-based: which shares count in the denominator?

Under the weighted-average method, the outcome depends critically on which shares are included in the formula base. There is no single standard formula; the contractual definition has to be drafted expressly.

Broad-based formulations typically use fully diluted shares. That means the denominator also includes ESOP, committed shares and convertible instruments. This broadens the formula base and is therefore milder for the holders of unprotected equity, especially founders.

Narrow-based formulations reduce the denominator. How much depends on the contractual definition: sometimes only actually issued shares count (excluding ESOP and options), sometimes only the shares of the protected preferred series count. The narrower the base, the stronger the price adjustment and the more additional shares the existing investor receives. The model here uses the strict variant, i.e. the protected series only.

Different economic intuitions sit behind the denominator question. The case for a broad base is consistency: if the original price per share was calculated on a fully diluted basis, the adjustment should be carried out on the same basis. The case for a narrow base, from the investor's perspective, is that the protection is intended to correct the pricing error affecting that investor's own series, so the shares of other shareholders are economically irrelevant.

In practice, there is no single “standard” weighted-average formula. Anyone negotiating such a clause should understand every single lever and draft it consciously.

Pay-to-play and sunset clauses

In some rounds, anti-dilution protection is conditional on the existing investor participating in the down round. This pay-to-play logic is meant to prevent investors from claiming protection without contributing fresh capital. In the market, it is an additional negotiating lever, not an automatic feature.

Anti-dilution protection can also be limited in time by a sunset clause. A typical formulation provides that the protection falls away after a certain period or after the next financing round if that round was not a down round. From the founders' perspective, that reduces the long-term burden of protection rights whose justification diminishes over time.

How to read it in the term sheet

Anti-dilution rarely stands alone. Valuation, liquidation preference and other economic provisions in the investment agreement interact. Anyone trying to understand the economic balance of a financing round should read those provisions together.