Equity
Full Ratchet vs. Weighted Average: What Anti-Dilution Costs Your Common Stock in a Down Round
Anti-dilution moves your investors' conversion price, not their preference. The math on full ratchet vs. weighted average, and what each one does to your 409A.
By 409.AI Team - 2026-09-17
# Full Ratchet vs. Weighted Average: What Anti-Dilution Costs Your Common Stock in a Down Round
Your Series A investors bought in at $2.00 a share. Eighteen months later, the only term sheet on the table prices the next round at $1.00. Before you get to what that does to your team's options, there's a clause in your certificate of incorporation that decides how much of the company those Series A investors end up owning. It isn't the liquidation preference. It's the conversion price adjustment, and depending on how it was drafted it costs your common holders about a point and a half or well over seven.
Capital hasn't dried up. US startups raised more than $400 billion in the first half of 2026, but that money concentrated in AI and mega-rounds, according to the [PitchBook-NVCA Venture Monitor](https://nvca.org/pitchbook-nvca-venture-monitor/). For companies outside that lane, flat rounds, structured rounds, and milestone tranches are how deals get done. Each of those can trip a clause that's been sitting quietly in your charter since the Series A closed.
What anti-dilution actually adjusts
Preferred stock converts into common at a ratio, and that ratio is the original issue price divided by the conversion price. At closing, both numbers are the same, so 5,000,000 shares of Series A convert into 5,000,000 shares of common and nobody thinks about it again.
An anti-dilution provision lowers the conversion price when the company issues stock below what the investor paid. The original issue price stays fixed. The conversion price drops, the ratio climbs above 1:1, and the same certificate now converts into more common shares than it used to.
Two consequences follow, and founders regularly get the second one backwards.
The liquidation preference usually doesn't move. In the standard [NVCA model certificate of incorporation](https://nvca.org/model-legal-documents/), the preference is defined off the original issue price and adjusts only for splits, combinations, and recapitalizations. Your Series A investors put in $10 million, and after a down round they still sit in front of $10 million. What changes is the conversion, which is what governs the upside once the preference stack is cleared.
The extra shares come out of everyone who isn't protected. Common stock holders, option holders, and any investor whose own clause is weaker than the one firing.
The cap table
Take a company with 8,000,000 shares of common held by founders and early employees, a 2,000,000 share option pool, and a Series A of 5,000,000 preferred shares sold at $2.00 for $10 million. Fully diluted, that's 15,000,000 shares.
The Series B raises $6 million at $1.00 a share, so 6,000,000 new preferred shares. Without any anti-dilution adjustment, the company lands at 21,000,000 fully diluted shares and the founders and employees hold 38.1% of them.
Now run the clause three ways.
Full ratchet: the conversion price resets to the new price
A full ratchet drops the Series A conversion price to $1.00. It doesn't care that the Series B was small. One share issued at $1.00 produces the same reset as six million of them.
The conversion ratio becomes $2.00 / $1.00, or 2.0. Those 5,000,000 Series A shares now convert into 10,000,000 shares of common. Fully diluted shares jump to 26,000,000, and the founders and employees drop to 30.8%.
Read that carefully. A $6 million round handed the Series A investors 5,000,000 additional common shares, and their $10 million preference didn't budge. Full ratchets appear in genuinely distressed rounds and in bridge financings where the new investor is the only party at the table. They're rare in a first priced round and worth real negotiating capital to keep out.
Weighted average: the adjustment scales with the damage
Weighted average is the market standard, and it does what the name suggests. It reprices the Series A partly, in proportion to how much cheap stock the company actually issued relative to what was already outstanding.
The formula in the NVCA charter is:
CP2 = CP1 × (A + B) / (A + C)
- **CP1** is the conversion price in effect before the new issuance, here $2.00.
- **A** is the shares deemed outstanding immediately before the round.
- **B** is the number of shares the new money would have bought at the old price, so $6,000,000 / $2.00 = 3,000,000.
- **C** is the number of shares actually issued, 6,000,000.
Everything turns on how the charter defines A, and that single definition is the difference between the two versions of the clause you'll see in term sheets.
Broad-based
A broad-based clause counts the whole fully diluted capitalization in A: common, preferred on an as-converted basis, and outstanding options and warrants. Here that's 15,000,000.
CP2 = $2.00 × (15,000,000 + 3,000,000) / (15,000,000 + 6,000,000) = $1.7143
The conversion ratio becomes 1.1667, the Series A converts into 5,833,333 common shares, and the company ends at 21,833,333 fully diluted. Founders and employees hold 36.6%. The clause cost them about 1.5 points relative to no protection at all.
One detail gets negotiated more than founders expect: whether the *unallocated* option pool counts inside A. Including it makes A bigger, which makes the adjustment smaller and the clause friendlier to common. Read your own charter rather than assuming, because drafts vary.
Narrow-based
A narrow-based clause counts only the outstanding preferred on an as-converted basis in A. That's 5,000,000 here, so the denominator shrinks and the adjustment bites harder.
CP2 = $2.00 × (5,000,000 + 3,000,000) / (5,000,000 + 6,000,000) = $1.4545
The ratio becomes 1.375, the Series A converts into 6,875,000 shares, and founders and employees land at 35.0%.
The four outcomes side by side
| Clause | Series A conversion price | Series A as-converted shares | Fully diluted total | Founders and employees | |---|---|---|---|---| | None | $2.0000 | 5,000,000 | 21,000,000 | 38.1% | | Broad-based weighted average | $1.7143 | 5,833,333 | 21,833,333 | 36.6% | | Narrow-based weighted average | $1.4545 | 6,875,000 | 22,875,000 | 35.0% | | Full ratchet | $1.0000 | 10,000,000 | 26,000,000 | 30.8% |
Same round, same $6 million, same price. The spread between the best and worst version of this one clause is 5.9 percentage points of the company, and it was decided in a term sheet negotiation that probably took ten minutes.
What it does to your 409A
A down round pushes the common stock fair market value down on its own, which is the part everyone anticipates. We walked through the repricing problem that creates in [down rounds and underwater options](https://www.409.ai/articles/down-round-409a-underwater-options-repricing). The anti-dilution adjustment pushes it down a second time, through a different mechanism, and it's the one that gets left out of the data request.
Your appraiser allocates equity value across share classes using the breakpoints in the preference and conversion structure, usually through an option pricing model. We covered how that allocation works in [OPM vs. PWERM](https://www.409.ai/articles/409a-allocation-methods-opm-pwerm-backsolve). Below the preference stack, common gets nothing, and that stack is $16 million here in every scenario. Above it, value splits on an as-converted basis, and that's exactly the number anti-dilution just changed.
With no adjustment, the Series A holds 23.8% of the as-converted equity. Under a full ratchet it holds 38.5%. Every dollar of upside above the preference now splits differently, and there are more common-equivalent shares dividing the residual, so the per-share result for common falls twice over. The structural gap we described in [why your 409A comes in below your post-money](https://www.409.ai/articles/why-is-your-409a-valuation-lower-than-post-money-valuation) widens.
Treasury regulations require a reasonable valuation method that accounts for all information material to value, including recent arm's length transactions and the rights of each class of stock ([Treas. Reg. 1.409A-1(b)(5)(iv)(B)](https://www.law.cornell.edu/cfr/text/26/1.409A-1)). A triggered conversion adjustment is material information. Send the appraiser the amended charter, not a summary, and not a cap table export that still shows 1:1 conversion. Cap table software is frequently behind on this, because somebody has to enter the new conversion price by hand after the closing. The [documents that set your 409A timeline](https://www.409.ai/articles/409a-turnaround-time-data-request-checklist) include every charter amendment for exactly this reason.
What doesn't trigger it
A standard charter carves out a list of issuances that never count as a dilutive issuance. Options and restricted stock granted under the board-approved plan are excluded, which is why refreshing the pool doesn't reprice anybody's preferred. So is stock issued in an acquisition, on conversion of outstanding convertible securities, and to lenders or lessors in an equipment or venture debt facility, provided the board approves it. That last carve-out is why the [warrants attached to a venture debt facility](https://www.409.ai/articles/venture-debt-warrants-valuation-409a-cap-table) usually don't set off the clause on their own.
Two situations deserve a closer read. First, a tranched financing: the NVCA updated its model documents in October 2025 and again through 2026 to add mechanics for time- and milestone-based tranches, and whether a later tranche priced below the first one counts as a new dilutive issuance depends on how the closing is papered. Second, convertible instruments already outstanding. Most charters exclude shares issued on conversion of securities that existed before the adjustment, which means a SAFE converting at a low cap may not trigger anything, though the [dilution it creates is real either way](https://www.409.ai/articles/how-safes-affect-your-409a-valuation).
Pay-to-play changes who keeps the protection
In a real down round, the negotiation often isn't about the formula. It's about who still deserves the clause.
A pay-to-play provision says an existing investor who doesn't buy its pro rata share of the new round loses something: the preferred converts to common, or converts into a shadow series with no anti-dilution rights going forward. The effect is to concentrate protection among the investors still writing checks and to clean up the preference stack, which helps common in the [exit waterfall](https://www.409.ai/articles/liquidation-preferences-waterfall-common-stock-exit).
If your Series B investor is pushing a full ratchet, a pay-to-play is the trade worth asking for. It also tends to pull existing investors back into the round, which is usually the point.
The practical version
Pull your certificate of incorporation, find the conversion price adjustment section, and answer three questions before your next term sheet goes out.
Is it weighted average or full ratchet? Is A defined broadly, and does it include the unallocated pool? And which issuances are carved out?
If you're already negotiating a round below your last price, model the clause at the actual price before you sign, not after. The founders in the table above lost 7.3 points instead of 1.5, and the entire difference sat in a definition they could have negotiated. Once the round closes, tell your valuation provider what moved. A [409A valuation](https://www.409.ai/products/409a) built off a stale conversion ratio produces a strike price you'll have to explain to an auditor later, and that conversation goes better when the charter and the model agree.