Hemrock
Sign in

Anti-Dilution

How to model anti-dilution for equity shareholders in the Cap Table and Exit Waterfall Tool

What is anti-dilution?

Anti-dilution protection shields existing shareholders from ownership or value dilution.

Anti-dilution works by adjusting the preferred-to-common conversion ratio. Normally one preferred share converts to one common share; anti-dilution increases the number of common shares per preferred to offset value dilution.

Anti-dilution comes in two flavors:

  • Full ratchet — full protection. The conversion ratio reprices existing shares to the new round. Very dilutive to common. Rare.
  • Weighted average — partial protection. New conversion price ends up between the original issuance price and the new share price. Broad-based uses fully-diluted shares; narrow-based uses issued and outstanding (excluding options and warrants). Broad-based is more common.

Impact on cap tables

Cap tables can be viewed two ways:

  1. Issued and outstanding — shares actually issued.
  2. Fully-diluted — issued plus reserved for options and warrants.

Value-based anti-dilution changes the conversion ratio per share, which changes the fully-diluted count but not issued and outstanding. A conversion ratio of 1.00 means 1 preferred = 1 common. If anti-dilution has triggered, the ratio will differ.

The conversion ratio is the original equity issue price divided by the conversion price. Normally equal, so the ratio is 1.00. In a down round, if original shares had anti-dilution protection, the conversion price resets.

New Conversion Ratio = Original Equity Issue Price / New Conversion Price

Full ratchet — the new conversion price equals the new financing price.

New Conversion Ratio = Original Equity Issue Price / New Equity Issue Price

Weighted average:

New conversion price = Prior Conversion Price * (Fully-diluted Shares prior to the dilutive round + Number of shares that would have been issued in the new round using the prior conversion price) / (Fully-diluted Shares prior to the dilutive round + Number of shares that were issued in the new round using the new equity share price)

Broad-based uses fully-diluted shares; narrow-based uses issued and outstanding.

Worked example with sample cap tables: Allen Latta's Anti-Dilution Protection: An Overview.

Impact on exit waterfalls

Calculating preferred returns in a liquidity event requires determining whether preferred holders keep their preferred (take liquidation preferences) or convert to common (take the common distribution), accounting for any participation rights.

Anti-dilution does not change the liquidation preference — that stays at the original price paid — but it does change the conversion ratio, so use the adjusted ratio when calculating proceeds to preferred and the fully-diluted share count.

Terms and calculations: Modeling Exit Waterfalls

How the Cap Table and Exit Waterfall Tool calculates anti-dilution

The free Cap Table and Exit Waterfall Tool includes a sheet with prebuilt anti-dilution (beta). Key notes:

  • A conversion ratio column sits between issued and outstanding and fully-diluted.
  • The anti-dilution section takes an input for the prior price paid per preferred share.
  • If enabled, the section calculates full ratchet, broad-based, and narrow-based. A dropdown at the bottom selects which to apply.
  • Original preferred purchase price is a manual input — the model doesn't pull it from prior rounds, so you can use the prefinancing cap table without modeling history.
  • By default only old equity gets the adjusted ratio. Split shareholders across multiple rows if they invested in multiple rounds.
  • If investors invested at different prices, replicate the anti-dilution calculations for each class separately and link each conversion ratio into the cap table.
  • The exit waterfall already used the conversion ratio; the update enabled the keep-vs-convert test per shareholder using proceeds per share to common.

Additional Resources