What Is a Price-Based Antidilution Adjustment?

by Scott Edward Walker on February 17th, 2011


This post originally appeared as part of the “Ask the Attorney” series I am writing for VentureBeat.  Below is a longer version.  Please shoot me any questions in the comments section or, if you prefer confidentiality, via email at .


My co-founder and I have a question regarding the term sheet we just received from a VC.  We don’t understand what a price-based antidilution adjustment is and what it’s meant to address.  The exact language under that section reads as follows: “Subject to standard and customary exceptions, the conversion ratio for Preferred Stock shall be adjusted on a broad weighted average basis in the event of an issuance below the Preferred Stock price, as adjusted.”  Could you please explain?  Thanks!


A price-based antidilution adjustment is a mechanism to protect investors in the event that the company sells securities at a price lower than the price paid by such investors; it is complicated and can be devastating to the founders.

You first must understand that upon the issuance of preferred stock to an investor in a Series A round, the investor has the right to convert the preferred stock into common stock, and the conversion ratio is initially set at one-for-one.   The formula for determining the conversion ratio is (i) the original issuance price of the preferred stock divided by (ii) the conversion price (which initially is the original issuance price).

For example, let’s assume that XYZ Inc. raises $3 million in a Series A round at a $12 million pre-money valuation, and there are 4 million shares of common stock outstanding.  The investor thus receives 1 million shares of preferred stock at $3 per share; the conversion ratio is initially 1.  Now let’s assume a Series B round 18 months later in which XYZ raises another $3 million from a new investor, but at a pre-money valuation of $6 million with 5 million shares outstanding (and no options issued yet).  Each share of Series B Preferred Stock is thus priced at $1.20 per share ($6,000,000 divided by 5,000,000 shares), and 2,500,000 new shares must be issued to the Series B investor to raise the same $3 million.

XYZ thus issued 2.5x as many shares to the Series B investor in the down-round to raise the same amount of cash.  As a result, without antidilution protection, the Series A investor would only own 13.3% of the company (and the Series B investor would own 33.3%), on an as-converted basis.  Simply put, this is what a price-based antidilution adjustment is designed to address.  The position of the Series A investor is that it valued the company way too high and therefore should be able to “recover” its overpayment by adjusting the conversion ratio.

There are two basic types of price-based antidilution adjustments: (i) “full ratchet” (or “ratchet”) and (ii) “weighted average.”

Full Ratchet.  A full ratchet antidilution adjustment is draconian to the founders (and other holders of the company’s common stock) and thus is relatively rare.  This type of adjustment “ratchets” down the conversion price to the lowest price at which stock is issued after the issuance of the investor’s preferred stock – regardless of the number of shares issued.  In the example above, the conversion price would be $1.20 and the conversion ratio would be 2.5 (3 divided by 1.2).  Note that the same conversion ratio would result even if the company issued just one share for a price of $1.20.

Weighted-Average.  By use of complicated formulas, a weighted-average antidilution adjustment takes into account both (i) the lower price and (ii) the actual number of shares issued in the down round; it is therefore more moderate and indeed more accurately reflects the dilutive effect.  Accordingly, the greater the number of shares that are issued at a lower price the more significant the adjustment to the conversion ratio.

There are two categories of weighted-average formulas: broad-based and narrow-based.

In a broad-based weighted-average formula, the dilutive issuance is weighted against the fully diluted capital stock of the company (i.e., it assumes conversion of all preferred stock, warrants, stock options and other convertible securities).  In a narrow-based weighted-average formula, the dilutive issuance is only weighted against the outstanding securities and does not include convertible securities. A broad-based formula thus compares a dilutive issuance to a larger pie making the issuance appear less significant and therefore more appealing to the founders.


Based on the foregoing, the language in your term sheet (i.e., “adjusted on a broad weighted average basis”) is generally the best you’re going to get with respect to this issue.  Good luck.

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