Anti-Dilution Provisions (Full Ratchet and Weighted Average)

ANTI-DILUTION PROVISIONS

Drafting Guide: Full Ratchet vs. Broad-Based / Narrow-Based Weighted Average

1. OVERVIEW

Anti-dilution provisions protect holders of Preferred Stock from economic dilution when the Company issues new securities at a price below the Preferred Stock's original issue price (a "Down Round" or "Dilutive Issuance"). The protection adjusts the Conversion Price of the Preferred Stock (the denominator in the as-converted calculation), so that upon conversion, the Preferred Stock converts into more shares of Common Stock than it would have absent the adjustment.

Two principal approaches:

2. FULL RATCHET (CHARTER PROVISION)

(For inclusion in the Certificate of Incorporation as a Section of the Preferred Stock terms)

Section [___]: Adjustments to the Conversion Price — Full Ratchet

(a) Full Ratchet Adjustment. If the Company issues any Additional Shares of Common Stock (as defined below) for a consideration per share less than the Conversion Price of the [Series ___ Preferred Stock] in effect immediately prior to such issuance, then the Conversion Price of the Series [___] Preferred Stock shall be reduced to a price equal to the consideration per share received by the Company for the Additional Shares of Common Stock so issued.

(b) Formula. For each Dilutive Issuance:

NEW CONVERSION PRICE = New Issuance Price per share

(c) Illustrative Example. If the Series [___] Preferred Stock has a Conversion Price of $10.00 and the Company issues additional shares at $4.00, then the Conversion Price of the Series [___] Preferred Stock is reduced to $4.00, causing each share of Preferred Stock to convert into 2.5 shares of Common Stock instead of 1.0 share.

3. BROAD-BASED WEIGHTED AVERAGE (CHARTER PROVISION — DEFAULT)

(For inclusion in the Certificate of Incorporation; this is the market-standard formulation)

Section [___]: Adjustments to the Conversion Price — Broad-Based Weighted Average

(a) Broad-Based Weighted Average Adjustment. If the Company issues Additional Shares of Common Stock for consideration per share less than the Conversion Price of the Series [___] Preferred Stock in effect immediately prior to such issuance, then the Conversion Price of the Series [___] Preferred Stock shall be adjusted to equal the price determined by the following formula:

NCP = OCP × [(A + B) / (A + C)]

where:

(b) Common Stock Deemed Outstanding — Broad Base. "Common Stock Deemed Outstanding" at the time of any Dilutive Issuance means the sum of:

☐ All shares of Common Stock issued and outstanding;
☐ All shares of Common Stock issuable upon conversion of all outstanding Preferred Stock (on an as-converted basis);
☐ All shares of Common Stock issuable upon exercise of outstanding options, warrants, and convertible securities;
☐ All shares of Common Stock reserved and available for issuance under any equity incentive plan.

(c) Illustrative Example. Assume:

• OCP = $10.00
• A = 10,000,000 shares (broad base)
• New issuance = 1,000,000 shares at $4.00 per share, so aggregate consideration = $4,000,000
• B = $4,000,000 ÷ $10.00 = 400,000 shares
• C = 1,000,000 shares
• NCP = $10.00 × [(10,000,000 + 400,000) / (10,000,000 + 1,000,000)] = $10.00 × (10,400,000 / 11,000,000) = $10.00 × 0.9455 ≈ $9.45

(d) Exclusions. Notwithstanding the foregoing, no adjustment shall be made for:

☐ Shares of Common Stock issued upon conversion of Preferred Stock;
☐ Shares of Common Stock issued or issuable to employees, directors, consultants, or advisors under Board-approved equity plans (up to a specified cap);
☐ Shares of Common Stock issued as a stock dividend, stock split, subdivision, combination, or similar;
☐ Shares issued in connection with a bona fide acquisition, merger, joint venture, strategic transaction, or commercial arrangement approved by the Board (including consent of the Preferred Stock directors, if required);
☐ Shares issued in connection with equipment leases, commercial lending, or banking transactions, upon Board approval;
☐ Shares issued in an IPO.

4. NARROW-BASED WEIGHTED AVERAGE (CHARTER PROVISION — INVESTOR-FAVORABLE)

(Formula identical to Broad-Based except the definition of "Common Stock Deemed Outstanding")

Section [___]: Adjustments to the Conversion Price — Narrow-Based Weighted Average

The formula is identical to Section 3(a) above (Broad-Based Weighted Average). However, the definition of "Common Stock Deemed Outstanding" is narrower:

"Common Stock Deemed Outstanding" means only:

☐ The shares of Common Stock issuable upon conversion of the specific series of Preferred Stock for which the adjustment is being made (on an as-converted basis); AND
☐ The shares of Common Stock issued and outstanding as of the date of determination.

(It excludes unissued/unvested options, convertible securities, and unissued shares under the equity plan.)

A narrower base yields a lower "A" in the formula, producing a greater downward adjustment to the Conversion Price (more dilution protection for the Preferred).

5. ADDITIONAL PROVISIONS (COMMON TO ALL VARIANTS)

5.1 Deemed Issuances of Options and Convertible Securities

If the Company issues any Options or Convertible Securities after the Series [___] Original Issue Date, and the exercise or conversion price per share is less than the Conversion Price in effect immediately prior to such issuance, such issuance shall be treated as an issuance of Additional Shares of Common Stock.

• If the underlying Option or Convertible Security is later canceled, forfeited, or expires unexercised, the Conversion Price shall be readjusted as if such issuance had not occurred (to the extent applicable).

5.2 Certain Issuances for Non-Cash Consideration

If Additional Shares of Common Stock are issued for consideration other than cash, the fair market value of such consideration as determined in good faith by the Board (with approval of at least [one] Preferred Director) shall be deemed to be the consideration per share.

5.3 Stock Splits, Combinations, Reorganizations

Upon any stock split, stock dividend, combination, reclassification, or recapitalization, the Conversion Price and number of shares issuable shall be proportionately adjusted to prevent dilution or enlargement of rights.

5.4 Notice of Adjustment

Upon any adjustment to the Conversion Price, the Company shall promptly deliver to each holder of Preferred Stock a Certificate of Adjustment signed by an officer of the Company, setting forth in reasonable detail:

☐ The event requiring adjustment;
☐ The amount of the adjustment;
☐ The Conversion Price before and after the adjustment;
☐ The relevant calculations.

5.5 No Impairment

The Company shall not, by amendment of its Certificate of Incorporation or any reorganization, transfer of assets, consolidation, merger, dissolution, issue, or sale of securities, avoid or seek to avoid the observance or performance of any term of the anti-dilution provisions, but shall at all times in good faith assist in carrying out the intent of such provisions.

5.6 Pay-to-Play Interaction

The anti-dilution protection shall not apply to any holder that fails to participate in a Qualified Financing triggering pay-to-play conversion. In such case, the holder's Preferred Stock shall convert pursuant to the pay-to-play provision and shall not receive anti-dilution adjustment.

6. COMPARISON TABLE

(For negotiation/diligence only; not for inclusion in the charter)

7. ILLUSTRATIVE CALCULATIONS (SAMPLE DOWN-ROUND SCENARIO)

Assumptions:

• Pre-round Cap Table (fully diluted): 10,000,000 shares Common (incl. options, convertibles, unissued plan)
• Series A outstanding: 2,000,000 shares at OCP = $5.00 per share (Series A originally issued at $5.00)
• Series B Dilutive Issuance: 2,000,000 shares at $2.50 per share (i.e., a down round)

8. DRAFTING PITFALLS / NEGOTIATION POINTS

9. SOURCES AND REFERENCES

• NVCA Model Certificate of Incorporation (anti-dilution sections): https://nvca.org/model-legal-documents/
• Delaware General Corporation Law § 151 (Classes of stock): https://delcode.delaware.gov/title8/c001/sc05/
• ABA Private Target M&A Deal Points Studies (anti-dilution trends)
• "Venture Deals" by Brad Feld & Jason Mendelson (industry reference)
• Cooley GO Docs — Model Anti-Dilution Provisions: https://www.cooleygo.com/documents/

Disclaimer: This template is provided for informational purposes only and does not constitute legal advice. Anti-dilution provisions are mathematically and legally complex; drafting errors can cause material economic dilution or enrichment. Always engage qualified securities counsel to draft, review, and interpret these provisions.