Term sheet clauses
Also called anti-dilution protection, ratchet
An anti-dilution provision adjusts an earlier investor's conversion price downward if the company later sells shares at a lower price, compensating them for the drop by giving them more shares on conversion.
Broad-based weighted average is the market standard. It adjusts the conversion price partially, in proportion to how much new stock was issued at the lower price relative to the existing share count. A small down round produces a small adjustment.
Full ratchet is the aggressive version. It resets the earlier investor's conversion price to the new lower price regardless of how few shares were sold at it. Issuing even a token amount of cheap stock can massively increase the earlier investor's share count.
Narrow-based weighted average sits between the two by counting a smaller share base in the formula, producing a larger adjustment than broad-based.
The adjustment is paid in dilution by everyone without the protection, which in practice means founders and employees. Anti-dilution does not create value; it moves it from common to preferred at the worst possible moment.
Standard carve-outs exclude option pool issuances, shares issued in acquisitions and certain conversions, so ordinary corporate activity does not trigger the ratchet.
An issuance of shares at a price below the earlier investor's conversion price, subject to the carve-outs in the documents, which normally exclude option pool grants and acquisition shares.
It is rare in healthy rounds and usually signals distress or an investor with strong leverage. Founders should push for broad-based weighted average, which is the market norm.
Common shareholders, meaning founders and employees, through additional dilution. The protected investor receives more shares without investing more money.
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