Meaning
Contract provisions protect early-stage investors from equity reduction during down rounds by automatically adjusting the conversion ratio of preferred shares. Incorporating an anti dilution clause into a term sheet establishes a legal commitment to adjust share allocations when subsequent financing occurs at a lower share price. This calculation relies on pre-negotiated formulas rather than verbal agreements or retroactive negotiations.
Conversion Adjustment
Adjustments occur automatically when the trigger event of a down round is documented in a stock purchase agreement. The presence of an anti dilution clause alters the capitalization mechanics by creating a conditional claim on additional common shares for preferred holders. Startups must trace these adjustments in their share register to maintain an accurate account of outstanding commitments.
Financial Consequence
Down rounds generate substantial increases in the share count of preferred holders while diluting early founders and employees. Dilution calculations must account for the specific formula used, which ranges from broad-based weighted average to full ratchet. The full-ratchet method carries a heavy cost in founder ownership because it resets the conversion price to the new, lower round price regardless of the size of the round.
Record Integrity
Disagreements over calculations arise when historical contracts lack clear definitions of excluded share categories.
