Down-Round Protection / Ratchet

Down-round protection mechanisms — collectively called anti-dilution provisions — adjust an investor's economics when a company raises new capital at a price below the investor's original price. There are two main flavors: full ratchet and weighted-average (broad-based or narrow-based).

Full ratchet: the investor's conversion price is adjusted all the way down to the new round price, regardless of the size of the down round. Even one share sold at a lower price reprices the entire prior investment. This is the most investor-friendly but most founder-punishing form.

Weighted-average anti-dilution: the conversion price is adjusted proportionally, based on the relative size of the new (lower-priced) issuance versus the total outstanding shares. Broad-based weighted-average (which includes all dilutive instruments in the denominator) is less investor-protective than narrow-based (which excludes option pools).

Illustrative example: an investor paid $10/share for Series B shares. The company later raises at $5/share (a 50% down round). Under full ratchet, the investor's effective price is repriced to $5 — they now effectively own twice as many shares as before (for the same dollar invested). Under broad-based weighted-average, the repricing is proportional and less extreme.

The gotcha: anti-dilution protections are born by common shareholders. Every time an investor's preferred converts at a more favorable ratio, the common share count is diluted. Employees holding common shares or options are the primary absorbers of anti-dilution economics. Secondary buyers of common should model the down-round scenario explicitly.