What Is an Anti-Dilution Clause in Startup Funding?

An anti-dilution clause is a provision in a funding contract that protects investors from losing too much economic value if your startup later raises money at a lower valuation than a prior round (a “down round”). In plain English, if you sell new preferred shares cheaper than an earlier investor paid, the anti-dilution clause adjusts that earlier investor’s conversion price so they effectively get more shares per dollar invested. That adjustment preserves more of their ownership and shifts extra dilution onto founders and other common shareholders.

Anti-dilution protections typically sit in your preferred stock financing documents (term sheet, stock purchase agreement, and charter), and apply when the company issues new shares below the prior round’s effective price. They don’t stop dilution entirely – everyone gets diluted when you issue new shares – but they change who takes the bigger hit.

Why Investors Ask for Anti-Dilution

From the investor’s perspective, anti-dilution is a way to:

Reduce downside risk if the company stumbles and later needs capital at a lower valuation.
Keep their ownership and economics closer to what they expected when they invested.
Signal to their own limited partners (LPs) that they negotiated standard protections in a venture deal.

From a founder’s perspective, these same protections:

Can increase dilution (sometimes significantly) if you hit a rough patch and raise a down round.
Can make cap tables more complex and less attractive to future investors if anti-dilution terms are too aggressive.

That’s why it’s important to understand which type of anti-dilution you’re agreeing to, and how it behaves under different fundraising scenarios.

The Two Main Types of Anti-Dilution: Full Ratchet vs. Weighted Average

1. Full Ratchet Anti-Dilution

Full ratchet is the most investor-favorable (and founder-unfriendly) version. If you issue any new shares at a lower price than a prior investor paid, that investor’s conversion price gets reset all the way down to the new, lowest price. Let’s look at how this works with a simplified example.

We’ll use the following assumptions:

A founder owns 8,000,000 common shares in the startup.
Series A investor invests $2,000,000 at 2.00 per share, getting 1,000,000 preferred shares.

So before the down round, the founder has 8 million shares and the Series A investor has 1 million shares. The founder’s ownership stake is 8 million / 9 million = 88.9%. The Series A investor’s ownership is 1 million / 9 million = 11.1%.

Now let’s see what happens after a down round:

The founder raises a Series B down round at 1.00 per share (lower than Series A), and a Series B investor puts in $1,000,000, receiving 1 million shares.

If there is no anti-dilution clause, then the founder’s ownership stake is 8 million / 10 million = 80%. Both the Series A and Series B investors would have an ownership stake of 10% (1 million / 10 million).

Now we’ll look at the same scenario under a full-ratchet anti-dilution clause:

Under full ratchet, the A investor’s effective price is reset from $2.00 to $1.00.
That means, when converting to common stock, their preferred stock converts as if they had originally invested at 1.00, doubling the number of common shares they receive. For their original $2,000,000, they are now treated as if they bought at $1.00, so they are effectively granted an additional 1 million shares and now own 2 million shares.
The new total shares are now 11 million (8 million founder shares + 2 million Series A investors shares + 1 million Series B investor shares.

So now the cap table will show that the founder owns 8 million shares out of 11 million (72.7%), the Series A investor owns 2 million shares (18.2%), and the Series B investor owns 1 million shares (9.1%).

The result is that the Series A investor’s percentage ownership is protected, and the extra dilution is pushed onto founders and other non-protected holders.

2. Weighted Average Anti-Dilution

Weighted average anti-dilution is much more common and is considered a compromise between investor protection and fairness to existing shareholders. Instead of resetting all the way to the new, lowest price, it uses a formula that blends:

The old conversion price.
The amount of money and number of shares in the old rounds.
The amount of money and number of shares in the new, cheaper round.

The new conversion price lands between the old price and the new low price, so the investor gets some protection but not a full reset.

There are two common variants:

Broad-based weighted average – counts all outstanding shares in the formula (more founder-friendly).
Narrow-based weighted average – uses a narrower share base, typically more favorable to investors.

The details vary from contract to contract (and the math can get complicated), but the main idea is that weighted average softens the impact relative to full ratchet.

Why Founders Need to Care

Anti-dilution clauses only “activate” in a down round, so they’re easy to ignore during a hot market or an up round. Founders should still care because:

You’re pricing future downside today. Generous anti-dilution says, “If things go badly, founders and common holders will eat more of the loss.”
Early terms set precedents. If you grant very aggressive protection in an early round, later investors may ask for equal or better terms, compounding the effect.
They shape your future fundraising options. Harsh anti-dilution can make future rounds harder to structure because new investors don’t want to over‑dilute founders or trigger big windfalls to earlier investors.

Even if you’re confident you’ll never raise a down round, it’s safer to understand the mechanics than to assume the clause is “just standard boilerplate.”

How Anti-Dilution Shows Up in Your Cap Table

When a down round happens:

New shares are issued to the new investors at a lower price.
The anti-dilution formula adjusts the conversion price of the protected preferred.
That converts into additional shares for those investors, without them putting in more cash.
The total share count goes up more than it would have without the clause, so founders and unprotected holders end up with a smaller percentage of the company.

You’ll see this in the cap table as extra shares allocated to prior investors, often as “anti-dilution adjustment” shares or via new conversion ratios on their preferred. This is one of the reasons it’s critical to:

Keep a fully-diluted cap table model that can simulate down-round scenarios.
Understand which rounds have anti-dilution protections and of what type.

Practical Tips for Founders Negotiating Anti-Dilution

Push for broad-based weighted average, not full ratchet. Full ratchet is extremely punitive in a down round and can make future financing very difficult.
Know which rounds have protections. Don’t assume later investors will accept weaker rights than earlier ones. A messy stack of different protections adds complexity.
Model down-round scenarios. Even just testing “What happens if we raise 25–50% below this round’s valuation?” can show you how painful certain clauses might become.
Limit scope where you can. In some negotiations, founders successfully limit anti-dilution applicability to specific circumstances or time periods.

Anti-dilution clauses don’t have to be scary, but they do need to be understood. A little modeling and expert guidance upfront can prevent a lot of issues later if the market turns and you’re raising in less-than-ideal conditions. Working with experienced startup counsel and a startup-focused CPA/finance team like Kruze can help you see how these terms play out on your cap table before you sign.