Two years after your first cheque, the founder emails to say the new round is coming in below the last one. The lead from that last round has an anti-dilution clause. You don't. By the time the paperwork settles, your slice of the company is smaller than you expected - and theirs is barely scratched.
That asymmetry is the whole story of anti-dilution. It's one of the least glamorous lines on a term sheet and one of the most consequential, because it decides who absorbs the pain when a company is worth less than it used to be. Most write-ups treat it as a formula problem. It's really a question of who's standing where when the music stops.
What is an anti-dilution provision?
An anti-dilution provision is a clause attached to preferred shares that lowers the price at which those shares convert into ordinary shares if the company later issues new shares more cheaply. The clause doesn't hand the investor a fixed ownership percentage. It adjusts a conversion price, and a lower conversion price means more ordinary shares per preferred share when the time comes to convert - on a sale, say, or a listing.
Worth clearing up a common confusion first. Every shareholder gets diluted when new shares are issued - that's ordinary, expected, and not what this clause is about. Anti-dilution deals with the narrower case where the new shares are issued at a lower price than an earlier investor paid. The market's blunt name for that is a down round, and the clause exists to cushion the investor whose paper has just been repriced downward by people coming in behind them.
It decides who absorbs the pain when a company is worth less than it used to be.
Full ratchet or weighted average - what's the difference?
There are two main flavours, and the gap between them is large.
Full ratchet
Full ratchet resets the earlier investor's conversion price all the way down to the new, lower price - no matter how few shares were issued at that price. Issue a single share at half the previous valuation and, in a pure full-ratchet world, the earlier investor is treated as if they'd bought in at that half price too. It can roughly triple the dilution that the same down round would cause under the gentler method. Founders and ordinary shareholders eat the difference. You see it occasionally in distressed rounds where the new money holds all the cards; in a normal British seed or Series A it's rare, and rightly treated as aggressive.
Weighted average
Weighted average is the grown-up version and the one you'll actually meet. Instead of snapping to the new price, it sets a new conversion price somewhere between the old and the new, weighted by how much the down round raised relative to the shares already in issue. A small raise at a slightly lower price barely moves the dial; a large raise at a punishing price moves it more. The logic is proportionate, which is precisely why it's become the default.
The standard formula looks like this:
New price = Old price × (A + B) ÷ (A + C)
- A - shares already in issue before the down round (the part that broad vs narrow decides).
- B - the number of shares the new money would have bought at the old price.
- C - the number of shares the new money actually buys at the new, lower price.
Because C is always larger than B in a down round, the fraction is below one, and the conversion price ticks down - but only by a blended amount, not the whole drop.
Broad-based or narrow-based - and why it matters
Within weighted average there's a second dial: what counts as "A", the existing share base. This is the broad-based versus narrow-based distinction, and it's quietly where a lot of the real money sits.
Broad-based counts a wide pool - ordinary shares, every class of preferred on an as-converted basis, and usually the unissued option pool too. A bigger A means a bigger denominator, which means a smaller adjustment. Narrow-based counts a thinner slice, often just the preferred series being protected. Smaller A, larger adjustment, more shares to the protected investor and more dilution to everyone else. Broad-based is the UK and US market norm; if you see narrow-based on a seed term sheet, it's worth asking why.
When it doesn't fire: the carve-outs
Anti-dilution doesn't trigger on every new share. The carve-outs - the list of issuances that are explicitly excluded - matter as much as the formula, because they decide how often the clause actually bites. Standard exclusions usually cover:
- Shares issued from the agreed employee option pool.
- Shares issued on conversion of existing instruments - convertibles, warrants, an earlier preferred series.
- Shares issued in an acquisition, a commercial partnership, or to a lender as part of debt finance.
- Share splits and bonus issues, which are mechanical and handled by separate adjustment language.
Read that list carefully on any sheet you're handed. A clause with a tight carve-out list fires more often than one with a generous one, and the difference rarely shows up in the headline summary.
Who does it actually protect?
Here's the part that catches British angels out. Anti-dilution attaches to preferred shares - the class institutional VCs typically take. But the SEIS and EIS reliefs that draw so many UK angels into early-stage deals require ordinary shares carrying no preferential rights. You can't hold SEIS-qualifying preferred shares; the schemes don't allow it. (HMRC's guidance on what qualifies is worth knowing before you sign anything - see gov.uk on the venture capital schemes.)
So in most rounds the SEIS/EIS angel sits on the diluted side of the table, not the protected side. When a down round triggers a lead investor's anti-dilution, it's the ordinary shareholders - founders, employees, and yes, the EIS angels - whose stakes shrink to make the protected investor whole. None of that changes the tax relief itself; the relief is fixed by what you paid and how long you hold (broadly, three years for both SEIS and EIS). It just means the equity you're protecting with that relief can be the equity doing the absorbing.
That's not a reason to avoid anything - it's a reason to read the cap table and the rights schedule together, not in isolation, so you know where you'd stand if the next round comes in low.
What to look at on the term sheet
You don't need to be a lawyer to spot the load-bearing words. Three quick reads: is it full ratchet or weighted average (you want to know if it's the harsh one); broad-based or narrow-based (broad is the norm); and how long the carve-out list runs. Those three between them tell you most of what the clause will do. The rest is arithmetic - and the arithmetic only ever runs if the company raises lower than it did last time, which is the outcome everyone at the table is trying to avoid in the first place.
Anti-dilution is, in the end, an argument about confidence. The investor who insists on a hard ratchet is pricing in the chance things go sideways; the founder who resists it is betting they won't. Where the line lands tells you something about how both sides really read the company - which is usually more honest than anything in the pitch deck.