The formula prices only the money raised below the old price, spread across the whole capitalisation, which is why it costs founders a point where a ratchet costs six.
Broad-based weighted average anti-dilution lowers an earlier investor's conversion price in a down round with the formula CP2 = CP1 × (A + B) / (A + C), where A is the fully diluted share count before the round, B the shares the new money would buy at the old price and C the shares it actually buys. On an illustrative company, a 6.0m round at 1.20 moves a 2.00 Series A conversion price to 1.82, worth 500,000 extra shares. A full ratchet would give 3,333,333.
Worked in full in The Venture Capital Associate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Anti-dilution protection is the clause that decides who pays for a down round. It does not issue new shares on the day: it changes the price at which the preferred converts into common, so the earlier investor owns more of the company when it does. The three standard versions use the same inputs and give very different answers, and the difference falls almost entirely on the founders and the option pool.
| Holder | Shares |
|---|---|
| Founders, common | 10,000,000 |
| Option pool, granted and ungranted | 2,000,000 |
| Series A preferred, issued at 2.00 (10.0m invested) | 5,000,000 |
| Fully diluted, before the round | 17,000,000 |
The Series B raises 6.0m at 1.20 a share, 40 per cent below the Series A price, and so issues 5,000,000 new shares.
CP2 = CP1 × (A + B) / (A + C)
A = shares before the round (broad: fully diluted; narrow: preferred only)
B = new money / CP1, the shares the round would buy at the old price
C = new money / new price, the shares it actually buys
In Excel: =CP1*(A+NewMoney/CP1)/(A+NewMoney/NewPrice), then =Invested/CP2 for the shares the Series A converts into.
Step 1, B and C. At the old 2.00 price the 6.0m would have bought 3,000,000 shares; at 1.20 it buys 5,000,000. The formula prices the 2,000,000 shares of difference, and only that.
Step 2, the new conversion price. Broad-based: 2.00 × (17,000,000 + 3,000,000) / (17,000,000 + 5,000,000) = 1.82. The Series A is not repriced to 1.20; it is repriced to the weighted average of everything issued, which the cheap round pulls down only a little because it is small relative to the company.
Step 3, the shares. The Series A's 10.0m now converts at 1.82 into 5,500,000 shares, 500,000 more than before. At the round price those shares are worth 0.60m, and that value comes from every other holder: the founders, the pool and, with its price fixed, the new investor too.
| Protection | New conversion price | Extra shares | Founders | Pool | Series A | Series B |
|---|---|---|---|---|---|---|
| None | 2.00 | 0 | 45.45% | 9.09% | 22.73% | 22.73% |
| Broad-based weighted average | 1.82 | 500,000 | 44.44% | 8.89% | 24.44% | 22.22% |
| Narrow-based weighted average | 1.60 | 1,250,000 | 43.01% | 8.60% | 26.88% | 21.51% |
| Full ratchet | 1.20 | 3,333,333 | 39.47% | 7.89% | 32.89% | 19.74% |
The broad-based clause costs the founders 1.01 points. The full ratchet costs them 5.98, because it reprices the whole 10.0m of the Series A to 1.20 regardless of how little was raised at that price, issuing 6.7 times as many extra shares. Narrow-based sits between the two: it uses only the 5,000,000 preferred shares as A, so the same cheap shares weigh more and the price falls to 1.60, issuing 1,250,000 extra shares.
Note also what the Series A actually recovers under the standard clause. Its 10.0m bought shares worth 6.00m at the new price; broad-based protection lifts that to 6.60m. Weighted average is a partial cushion, not insurance. Only the ratchet restores the full 10.00m.
| Series B price | Discount to A | Broad: new price | Broad: extra shares | Narrow: extra shares | Ratchet: extra shares | Founders, broad | Founders, ratchet |
|---|---|---|---|---|---|---|---|
| 1.80 | 10% | 1.97 | 83,333 | 208,333 | 555,556 | 48.98% | 47.87% |
| 1.50 | 25% | 1.90 | 250,000 | 625,000 | 1,666,667 | 47.06% | 44.12% |
| 1.20 | 40% | 1.82 | 500,000 | 1,250,000 | 3,333,333 | 44.44% | 39.47% |
| 0.80 | 60% | 1.63 | 1,125,000 | 2,812,500 | 7,500,000 | 39.02% | 31.25% |
The gap between the clauses widens fastest in a deep down round, exactly when the company can least afford it. At a 60 per cent discount a ratchet takes the founders to 31.25 per cent against 39.02 under broad-based terms, and a founder team below a third is a retention problem for the next investor.
The common mistake is to treat "weighted average" as one clause. Whether A is broad or narrow, and whether it includes the ungranted pool, warrants and convertible notes, moves the answer as much as most points negotiated in the term sheet: here 500,000 against 1,250,000 shares, two and a half times as many. Read the definition of shares outstanding before the round, not the label.
Price the round on the adjusted cap table. The tables above hold the Series B price fixed, so the anti-dilution shares dilute the new investor too, from 22.73 to 22.22 per cent. In practice the Series B investor will insist on a price set after the adjustment, which pushes more of the cost onto the founders and requires an iterative solve.
Compute B and C, apply CP1 × (A + B) / (A + C), and divide the original investment by the result: here 1.82 and 500,000 extra shares, against 3,333,333 under a full ratchet. The book's workbooks, a blank model set and twelve printable working documents are in the free companion files for The Venture Capital Associate, and the related pre-money mechanics are worked in how the option pool shuffle lowers the effective pre-money.
Only the definition of A, the shares outstanding before the round. Broad-based counts the whole fully diluted capitalisation, here 17,000,000 shares; narrow-based counts only the preferred, 5,000,000. The smaller A makes the new cheap shares weigh more, so the illustrative conversion price falls to 1.60 rather than 1.82, and the Series A receives 1,250,000 extra shares rather than 500,000.
A full ratchet resets the conversion price to the new round price whatever the size of the round, so a small financing at a low price reprices the whole earlier round. In the illustrative 6.0m round at 1.20 the ratchet issues 3,333,333 extra shares, 6.7 times the broad-based adjustment, and costs the founders 5.98 points of ownership instead of 1.01.
No. Weighted average only partly compensates. Without protection the Series A holds 22.73 per cent after the illustrative down round; the broad-based adjustment restores it to 24.44 per cent. At the new 1.20 price its 10.0m investment is worth 6.60m rather than 6.00m. Only a full ratchet restores the 10.00m, and it does so at the founders' expense.
This article is one calculation from The Venture Capital Associate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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