If you are raising venture capital, your term sheet will almost certainly include an anti-dilution clause. It is one of those provisions that looks innocuous on first read — a few lines about conversion price adjustments — but can fundamentally reshape your cap table if the company ever raises at a lower valuation. In a market where down rounds have become more common, understanding how anti-dilution works is not optional. It is essential.
What Anti-Dilution Actually Does
Anti-dilution protection compensates investors when a company issues new shares at a price lower than what those investors originally paid. This scenario — a “down round” — means the company’s valuation has declined since the earlier funding round.
Without anti-dilution protection, all shareholders are diluted equally when new shares are issued. Anti-dilution provisions override that default. They give protected investors the right to adjust their conversion price downward, which effectively increases the number of ordinary shares they would receive on conversion of their preference shares. The result is that the economic pain of the down round falls disproportionately on founders and other unprotected shareholders — typically anyone holding ordinary shares or options.
In Australian venture capital transactions, anti-dilution provisions are negotiated as part of the shareholders’ agreement. Unlike the US, where the National Venture Capital Association (NVCA) model documents provide a standardised starting point, Australian deals are more bespoke. That means the specific mechanics — and their impact on founders — vary significantly from deal to deal.
Full Ratchet: Maximum Investor Protection
Full ratchet is the most aggressive form of anti-dilution. It adjusts the investor’s conversion price to equal the price per share in the new (lower) round, regardless of how many shares are issued in that round.
Here is how it works in practice. Suppose an investor subscribes for Series A preference shares at $2.00 per share, acquiring 1 million shares for a $2 million investment. The company later raises a Series B at $1.00 per share — a down round.
Under a full ratchet, the Series A investor’s conversion price drops from $2.00 to $1.00. When they convert their preference shares to ordinary shares, they receive 2 million shares instead of 1 million. The investor’s economic position is restored as if they had invested at the lower price all along.
The problem is immediately apparent. The additional 1 million shares come from somewhere — and that somewhere is the founder’s percentage of the company. Full ratchet does not care whether the down round involved $100,000 or $10 million in new capital. A single share issued at a lower price triggers the same adjustment. This makes it extraordinarily punitive for founders.
Full ratchet provisions are rare in Australian deals and increasingly rare globally. Most experienced venture capital lawyers will advise against them except in unusual circumstances — such as bridge rounds where the investor is taking significant risk on a struggling company and wants robust downside protection.
Weighted Average: The Market Standard
Weighted average anti-dilution is more nuanced. Instead of resetting the conversion price to the new round price, it calculates an adjusted price that takes into account both the price and the number of shares issued in the down round.
The formula is:
Adjusted Price = Original Price × (A + B) / (A + C)
Where:
- A = total shares outstanding before the new issue (on a fully diluted basis)
- B = the number of shares the new money would have bought at the original price
- C = the number of shares actually issued in the new round
Using the same example — Series A at $2.00 per share, 10 million shares outstanding on a fully diluted basis, and a Series B raising $2 million at $1.00 per share (issuing 2 million new shares):
- A = 10,000,000
- B = $2,000,000 / $2.00 = 1,000,000
- C = 2,000,000
Adjusted Price = $2.00 × (10,000,000 + 1,000,000) / (10,000,000 + 2,000,000) = $2.00 × 11/12 = $1.833
The conversion price drops from $2.00 to $1.833 — a meaningful adjustment, but significantly less punitive than the full ratchet result of $1.00. The investor receives some protection proportionate to the size and severity of the down round, while founders retain substantially more of their equity.
Broad-Based vs Narrow-Based
Within weighted average anti-dilution, there is a further distinction that matters: whether the formula uses a broad base or narrow base for calculating total shares outstanding.
Broad-based weighted average includes all shares on a fully diluted basis in the denominator — ordinary shares, all series of preference shares (on an as-converted basis), outstanding options, warrants, and shares reserved under the employee share option plan. This produces a larger denominator, a smaller adjustment, and less dilution to founders. It is the market standard in both Australian and US venture deals.
Narrow-based weighted average only includes the particular series of preference shares being adjusted, or sometimes only all preference shares, excluding ordinary shares, options, and the ESOP pool. The smaller denominator produces a larger adjustment — closer to full ratchet in extreme cases.
Founders should always push for broad-based weighted average. It is the most balanced formulation, and most sophisticated investors will accept it as standard.
Why This Matters for Australian Founders
The practical impact of anti-dilution provisions only becomes apparent when things go wrong — which is precisely when you least want to be discovering what you agreed to.
Cap table compression. In a significant down round with full ratchet protection, founders can find their ownership reduced to single digits. Even with weighted average provisions, successive down rounds compound. Each adjustment increases the investor’s share at the founder’s expense, and the effect is cumulative.
ESOP dilution. Anti-dilution adjustments typically do not apply to the employee share option plan. Employees holding options at a higher exercise price find those options underwater, while the protected investors’ positions improve. This can devastate retention at exactly the moment the company needs its team most.
Knock-on effects. Anti-dilution adjustments can trigger flow-on consequences throughout the shareholders’ agreement. Voting thresholds based on percentage ownership shift. Board appointment rights tied to shareholding percentages may change hands. Liquidation preference waterfalls — already complex — become more so when conversion ratios have been adjusted.
Interaction with other protections. Anti-dilution does not operate in isolation. Investors who also hold participation rights and liquidation preferences benefit from multiple layers of downside protection. Founders negotiating anti-dilution should consider the cumulative effect of all investor protections, not each clause independently.
Negotiation Strategies for Founders
You are unlikely to eliminate anti-dilution entirely — it is a standard investor protection and resisting it outright signals inexperience. But you can negotiate the terms that matter.
Insist on broad-based weighted average. This is the single most important negotiation point. The difference between broad-based and narrow-based can be substantial, and any investor who insists on narrow-based or full ratchet is signalling an adversarial posture.
Negotiate a carve-out for the ESOP. Some shareholders’ agreements exclude shares issued under an approved employee share scheme from triggering anti-dilution adjustments. This prevents the perverse outcome where expanding your option pool to retain staff triggers a conversion price adjustment that benefits investors.
Include a pay-to-play requirement. A pay-to-play provision requires investors to participate in the down round (at least pro rata) to maintain their anti-dilution protection. If they do not invest in the new round, they lose the adjustment — or their preference shares convert to ordinary shares entirely. This aligns incentives: investors who are willing to back the company in difficult times keep their protection, while those who sit on the sidelines do not get a free ride.
Cap the adjustment. Some deals include a floor on the adjusted conversion price — for example, the price cannot adjust below 50% of the original issue price regardless of the down round price. This limits the worst-case dilution.
Sunset the protection. Anti-dilution provisions can include an expiry — for example, they cease to apply after a specified period or once the company reaches certain revenue or valuation milestones. This recognises that the risk of a down round diminishes as the company matures.
The Bottom Line
Anti-dilution clauses are a standard feature of Australian venture capital deals, and founders should expect to see them in any priced round. The critical question is not whether to accept anti-dilution protection, but which type and on what terms.
Full ratchet is punitive and should be resisted except in genuinely exceptional circumstances. Broad-based weighted average is the market standard, and for good reason — it gives investors meaningful downside protection while limiting the disproportionate impact on founders and employees.
The time to negotiate anti-dilution terms is before you sign the term sheet, not when a down round is looming. By then, you are negotiating from weakness. Get legal advice early, understand the mechanics, and push for terms that are fair to both sides. Your future self — and your cap table — will thank you.
