Anti-Dilution Clauses: How they affect your CapTable

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Key Takeaways

  • There are 2 broad categories of anti-dilution clauses: Weighted Average Cost of Capital (WACC) and Full-Ratchet
  • WACC anti-dilution clauses are much friendlier for founders, and are accepted by investors a vast majority of the time
  • Full-Ratchet anti-dilution is to be avoided as far as possible, given how founders risk quickly losing their majority shareholdings in their own company
  • Should a Full-Ratchet anti-dilution take place, the founders must work hard and grow the company, in order to reverse this provision in a later fundraising round

Introduction: What are anti-dilution clauses?

In the 10th and final article of our CapTable series, we touch on 1 final element of CapTable management that can potentially have mild or calamitous effects on a company: anti-dilution clauses.  

Anti-dilution clauses are provisions which allow investors to have some protection on their percentage shareholdings in the event that new shares are issued at a lower valuation – that is, when new investors come in with a lower price per share (in a down round).  This is done to compensate earlier investors when the company is not performing up to expectations.  Rather than issue new shares to incumbent investors, which complicates the price per share and the company’s ACRA filings, founders will simply update their incumbent investors’ shares according to a calculated conversion ratio, and make adjustments to the Fully Diluted CapTable to reflect the changes .  Post-conversion, the effective number of shares held by each incumbent investor will increase.  

However, with some level of protection for earlier investors’ percentage shareholdings, it also means that founders will suffer additional dilution each time a downround happens – on top of the dilution created by the incoming investors, anti-dilution clauses by incumbent investors further reduce the founders’ percentage shareholdings.  Should a specific anti-dilution clause be in effect, the founders can even lose their majority ownership in their own company in 1 fell swoop, which amounts to a loss of control over their own company.

2 broad categories of anti-dilution clauses

The first main anti-dilution clause is “weighted average cost of capital”, or WACC.  The term “weighted average” stems from how WACC uses different formulae to calculate a new conversion price or the conversion ratio, while taking into account the new price per share, as well as the prospective extent of dilution.  A vast majority of the time, investors will accept this as one an investment term.  

WACC can be further divided into broad-based or narrow-based WACC.  The key difference is that while broad-based WACC takes into account all equity previously issued, as well as equity currently being issued, narrow-based WACC for only preferred convertible shares, and excludes options, warrants or shares issued as part of stock or option incentive pools.  By extension, ESOPs are also excluded from narrow-based WACC calculations.  Given the breadth of equity considered, broad-based WACC is typically friendlier to the founders, as it dilutes them less.

While there are different formulae used to calculate the conversion price under WACC, typically, the following is used:

CP2 = CP1 ⨉ (a + b) / (a + c)

Notations wise, in the formula above:

  • CP2 = Conversion price (for relevant share series) in effect after new issue
  • CP1 = Conversion price (for relevant share series) in effect prior to new issue
  • a = Number of shares outstanding immediately prior to new issue
  • b = Aggregate investment in new round of financing, divided by CP1
  • c = Number of shares issued in the new round

Depending on whether broad-based or narrow-based WACC is used, the definition of a will either be broader or narrower, respectively.  For broad-based WACC, a will include outstanding ordinary shares, all outstanding preference shares, and all outstanding options exercised (but EXCLUDES convertible instruments converting in the upcoming round of financing).  For narrow-based WACC, a will only include all preference shares for the series. 

Alternatively, one common formula used to calculate the conversion ratio will be:

# of shares in issue after down-round (on an as-converted basis) ÷ [# of shares in issue prior to down round (on an as-converted basis) + (Total down round investment amount / Original Conversion Price)].

The second anti-dilution clause is called “full ratchet”.  Under full ratchet anti-dilution, existing shareholders will be converted based on the lowest sale price (or price per share) for the new round, regardless how much money is raised, or how much equity is issued, through the new round.  Full ratchet anti-dilution is considered extremely painful for founders, as it can immediately cause founders to lose their majority stake in, and control of, their company.  

A simple numerical illustration

Suppose we have Company A, which is about to undergo a down round.  The relevant details are as follows:

  • The company has 6,000,000 ordinary shares, issued at a price per share of $0.001 → Total = $6,000)
  • The company has 3,000,000 Series A shares, issued at a price per share of $1 (which also represents the original conversion price) → Total investment = $3,000,000
  • In the upcoming down round (denote this as Series B), a total of $1,500,000 will be raised, with 3,750,000 shares issued at a price per share of $0.40

Prior to the down round, the ownership structure of the company is as such:

Broad-based WACC:

We begin by working out the new conversion price for the Series A shares, which, post-conversion, will become Ordinary shares.  Using the conversion price formula stated above, the new effective Series A share price will be:

$1 ⨉ [(6,000,000 + 3,000,000 + 1,500,000) / (6,000,000 + 3,000,000 + 3,750,000)] = $0.824.  

This also means that the conversion ratio for the Series A shares will be: 1 / 0.824 = 1.214.

Post-conversion, the ownership structure of company (excluding the down round investors) will be:

Post-investment, the ownership structure of company will be:

While the founders have lost a significant share of their ownership post-investment, they still retain their majority ownership.  Importantly, most of the dilution to founders was from the inclusion of the Series B investors onto the CapTable.  This reflects the relative founder-friendliness of broad-based WACC.

Narrow-based WACC:

The formula used will be similar to broad-based WACC, except now the value of a will be smaller (in essence, a is more narrowly defined).

The new effective share price for Series A investors will be:

$1 ⨉ [(3,000,000 + 1,500,000) / (3,000,000 + 3,750,000)] = $0.667.

The equivalent conversion ratio is: 1 / 0.667 = 1.5

Thus, post-conversion, the ownership structure of the company (excluding the down round investors) will be:

Post-investment, the ownership structure of company will be:

Notice here that due to the more narrow definition of a, the calculated conversion ratio is higher than that applied in the broad-based WACC case, and the dilution to founders is larger as well (although it still does not create too much of a problem for the founders per se). This corroborates what we have earlier discussed: that broad-based WACC still provides better protection for the founders (or other classes of incumbent investors whose shares are not converted).


In the worst possible scenario, should a full-ratchet anti-dilution be used, the Series A investors will have their shares converted at $0.40 directly – that is, the lowest sale price of the new shares.  In other words, the conversion ratio will be: 2.5

Post-conversion, the ownership structure of the company (excluding the down round investors) will be:

Post-investment, the ownership structure of company will be:

As can be seen, without even including the downround investors, by a single anti-dilution conversion in this case, Founders A and B have instantly lost their majority shareholdings in their company – from 66.67% ownership, they now only own 44.44%. This problem is exacerbated when the downround investors are subsequently included in the CapTable.

What to do if a full ratchet must be accepted?

As far as possible, a full ratchet anti-dilution should be negotiated away prior to it coming into effect.  However, as earlier suggested, full ratchet is extremely rare today, and a company will have to truly be in a dire state before this provision would possibly be implemented.

However, if a full ratchet has to be suffered for 1 round, founders can try to reverse or do away with this anti-dilution provision in later fundraising rounds.  Assuming they work hard and turn the company around, should a regular or strong fundraising round occur later, the founders can negotiate with their incoming investors to buy over the previous tranche of investors who opted for a full ratchet, or have the new investors specify WACC as their preferred anti-dilution, as a requirement for them to invest.  Through the latter approach, the investors who opted for full ratchet will be pressured to accept these changes.  This may allow for subsequent re-conversion of shares, so that the founders enjoy a bump in their shareholdings.


There are 2 broad categories of anti-dilution: WACC (which can be further subdivided into broad-based or narrow-based WACC) and full ratchet.  WACC anti-dilution is far friendlier for founders, and fortunately, is accepted by most investors today.  Between broad and narrow-based WACC, broad-based WACC provides better protection for the founders.  In contrast, full ratchet anti-dilution tends to be extremely painful, to the point where founders may lose their majority share ownership (and thus, control over their own company).  In the highly unlikely event that a full ratchet must be accepted, the founders can only buck up, turn their company around, and negotiate away this provision in a later investment round.

DO TAKE NOTE, however, that anti-dilution formulae may vary from time to time.  It is therefore important for founders to understand how the formula works before signing any agreements with their shareholders.