You’ve just raised a round and handed out equity. Everyone’s excited. But what happens if your next round is at a lower valuation? Do early investors lose out? Does the team get diluted faster?
This is where anti-dilution protection steps in. It is a clause every founder should understand before signing their next term sheet.
Let’s break it down.
What is Anti-Dilution Protection?
Anti-dilution protection is a clause in investment agreements that protects investors from equity dilution if a startup raises money in the future at a lower valuation (a “down round”).
It ensures that early investors are compensated during a down round. This is done typically by adjusting the conversion price of their preferred shares, so that they receive more equity for the same investment.
Think of it as a safety net for investors but it can have serious implications for founders and the cap table.
When Does Anti-Dilution Kick In?
Anti-dilution protection is triggered only during a down round when new investors buy shares at a lower price per share than what earlier investors paid.
For example:
- Seed investor bought shares at ₹100 each
- Series A happens at ₹60 per share
- Anti-dilution adjusts the seed investor’s shareholding to compensate for this drop
Types of Anti-Dilution Protection
There are two main types founders should know:
1. Full Ratchet
- Converts the investor’s earlier shares as if they had invested at the new, lower price
- Most aggressive and founder-unfriendly
- Rare in mature ecosystems
Example: If the new round is at ₹60, the investor’s shares are all revalued to ₹60, which in turn leads to increasing their ownership significantly.
2. Weighted Average
- More common and balanced
- Adjusts the price based on how much capital is raised and at what price
- Protects investors without overly punishing founders
There are two sub-types:
- Broad-Based Weighted Average: Includes all shares (common + preferred)
- Narrow-Based Weighted Average: Considers only preferred shares, more investor-favorable
Why Does Anti-Dilution Matter for Founders?
Because it affects ownership, control, and morale. If a down round happens and anti-dilution kicks in:
- Founders and team get diluted more
- Early investors get a larger piece of the pie
- New investors might get less ownership for the same capital
- It can trigger co-founder misalignment or employee disillusionment
That’s why understanding these clauses and negotiating them smartly is crucial during fundraising.
Anti-Dilution in India: What’s Typical?
In India, weighted average anti-dilution is standard in most early-stage VC deals.
However:
- Full ratchet may still appear with aggressive investors or strategic funds.
- Some angel rounds use simplified notes (like SAFE or iSAFE), which may or may not include these clauses.
- Startups with strong founder leverage can sometimes negotiate this clause out entirely.
What Founders Can Do
Negotiate Scope
- Negotiate Scope: Try for broad-based weighted average as it’s more balanced. Avoid full ratchet unless absolutely necessary.
- Limit Triggers: Ensure the clause only applies in priced equity rounds, not in convertibles, grants, or special cases.
- Cap the Impact: Negotiate a maximum adjustment or time-bound limit (e.g., valid for 18–24 months).
- Balance with Other Terms: Anti-dilution is just one piece of the agreement. You should balance it with board control, liquidation preferences, and other founder protections.
Example of How a Down Round Changes Everything
Startup A raised a seed round at a ₹40 Cr valuation.
A year later, revenue slowed, and Series A came in at a ₹30 Cr valuation.
With full ratchet protection, the seed investor’s equity increased from 10% to 13.3%.
The founders and ESOP pool got diluted more than expected, which affected internal morale and future hiring. Had it been a weighted average clause, the dilution would’ve been milder and less damaging to team alignment.
Case Study: How Anti-Dilution Changed the Outcome for a SaaS Startup
Startup Name: Finlytics
Sector: B2B SaaS in Financial Automation
Founded: 2020
Seed Round: ₹5 Cr at ₹50 Cr valuation from two micro-VCs (2021)
Situation: Slower-than-expected revenue growth + shifting GTM strategy
By 2023, Finlytics needed to raise another round but faced tough market conditions and had to settle for a Series A at a ₹30 Cr valuation, which was a clear down round with 40% reduction in valuation.
What Went Wrong:
Their seed investors had full ratchet anti-dilution protection, which the founders hadn’t fully negotiated at the time (they were first-timers and chasing quick capital).
As a result:
- The seed investors’ original 10% stake was recalculated at the new Series A price, which resulted in bumping them up to 16.6% ownership.
- This caused additional dilution for the founding team and the ESOP pool.
- The new Series A investor was frustrated with the messy cap table and asked for extra rights to compensate.
- Internally, early team members were demotivated due to reduced ESOPs, forcing Finlytics to revise compensation packages.
Lessons for Founders:
- Full ratchet clauses can be punitive in downturns. Always push for weighted average, or at least cap the impact.
- A short-term win (closing a round fast) shouldn’t compromise long-term cap table health.
- Founders should always model different scenarios before agreeing to these clauses.
Final Thought
Anti-dilution clauses are designed to protect downside risk, but they can also reshape your cap table overnight.
For founders, understanding this clause is both about legal hygiene and about preserving long-term control, trust, and fairness.
Don’t just focus on valuation. Focus on what stays with you after the deal.