Negotiating a Term Sheet — Part 3: Anti-Dilution

Name Jamie Goldstein Partner at Pillar

Just got a term sheet from a VC firm?
Congratulations — that’s no small feat.

In this series, we are looking at the “standard” VC term sheet to understand each of the terms and conditions, why the VC might care and why you should as well.

In this Part 3, we look at Anti-Dilution.


Back to the NewCo example above. $5M raised at $10M pre-money at $0.85 per share, GlobalVC buying 5.88M shares. Imagine that for a variety of reasons, the company needs to raise another $5M and the market price is lower than the previous round, say 50 cents per share. Of course, nobody is happy with this development.

The standard VC term sheet has the concept of anti-dilution, meaning GlobalVC will be entitled to more shares (retroactively) to make up for this unfortunate circumstance.


There are two flavors:
A full ratchet or a weight-average ratchet.

A full ratchet is where all of their old money is repriced at the new round. Meaning instead of their old money buying shares at $0.85, they retroactively buy shares at 50 cents. So instead of having 5.88M shares they get 10M shares ($5M divided by 50 cents). Full ratchets are pretty rare nowadays and if your VC is proposing this, you might remind them this is 2019, not 1989. This is not market.

A weighted average ratchet is when the share price is adjusted using a formula that is the weighted average of old price and new price, weighted by how much capital came in at each. In our case, the weighted average of $5M at $0.85 and $5M at $0.50 is 67 cents. So the old money will be repriced at $0.67, giving the investor more shares. This is a “market” term.

I still find this term particularly offensive

That said, I still find this term particularly offensive — the company is struggling and this term benefits the investor at the direct expense of the Founders.

stay away from ratchets

Room to Negotiate?

I believe so. First off, a full ratchet shouldn’t even be on the table. If it is, something is very wrong. Your investor is signaling they think there’s a serious chance that the next round is a down round. Get to the bottom of this.

In trying to negotiate, I would think about three potential future scenarios.

Scenario 1 is where everything at the company is fine and future rounds are at increasing share prices. Anti-dilution does not apply here. This is the plan after all…

Scenario 2 is where GlobalVC is still a believer in the company and wants to contribute some of the new $5M round. In this case, they will be buying stock at a lower valuation than before, averaging down their costs. They are essentially getting a “weighted average” they just have to write a check to do so. The right investor would not want to pile on here and create additional misery to the Founders and further demotivate the team by “taking” their stock. It is somewhat of a litmus test. This case needs to be made directly to the investing Partner — not through layers of lawyers.

Scenario 3 is where GlobalVC no longer has faith in the company and doesn’t want to put any of the $5M in. In this case, the company — without the support of existing investors — is a good candidate to get recapped, that is, if a new investor showed up, they would reduce all existing equity and preference dramatically (possibly wiping it out entirely) and restart the company with a new capitalization. In this case, GlobalVC would be reduced to zero or darn close to it. The possibility of them getting more “free” shares at the time of this new financing makes it even more likely a new investor would insist on a recap. It is actually self-defeating. Again, a senior partner at GlobalVC should understand this — but the case needs to be made directly.

To Sum Up

Scenario 1

Anti-Dilution doesn’t apply

Scenario 2

If they participate, they are averaging down their costs anyway.

Scenario 3

The VC gave up. You could argue (gingerly) that they don’t deserve to own anything and anti-dilution makes a recap even more likely.

Recognize that some VC firms simply are not going to change these terms — not wanting to set a precedent for other future companies. Make the case, have the discussion. If nothing else, you’ll learn more about how your investing partner views the world.