Anti-Dilution Protection

Anti-dilution protection mitigates economic dilution for investors when new shares are later issued at a lower price. If the protection is triggered, the investor's original entry price is mathematically adjusted downward. As compensation, the investor receives additional shares. The clause is triggered by a down round, meaning a financing below the previous price per share.

Two mechanics exist. Under a full ratchet the entry price is reset entirely to the new, lower price regardless of how small the new round is, which is the harshest version for founders. Under a weighted average the adjusted price is calculated as the old price multiplied by the sum of existing shares plus the shares purchasable at the old price, divided by the sum of existing shares plus the shares actually issued. The effect here depends on the size of the new round, which makes the adjustment considerably milder.

Within this variant, broad-based and narrow-based differ according to whether options and convertible instruments are counted in the share base. The broad base favours founders. Broad-based weighted average is market standard in German venture capital, while full ratchet appears mainly in distressed situations and where the investor has very strong leverage. The protection is often combined with a pay-to-play provision under which it is available only to investors who participate pro rata in the new round.

In Germany the adjustment is usually implemented through a capital increase at nominal value in favour of the protected investor. For assessing a specific case the decisive question is which issuances trigger the protection at all: exceptions are customary for shares from an employee plan, for the conversion of existing instruments, for shares issued in connection with an acquisition and for issues to strategic partners. Whether creating or using an option pool triggers an adjustment depends on the contractual definition. The time horizon must also be settled, since open-ended protection complicates later rounds and is therefore often limited to the next financing.