What Is Anti-Dilution Protection, and How Does it Work in a Down Round?

Key takeaways

• Price protection, not percentage protection: Anti-dilution protection compensates investors when shares are later issued at a lower price. Pre-emption rights, by contrast, let shareholders keep their percentage by investing again. 

• Full ratchet or weighted average: A full ratchet resets the investor’s price to the new, lower price. A weighted average adjustment also takes account of how much money the down round raises, and is far more common. 

• The mechanics need company law authority: Bonus issues, subscriptions at nominal value and conversion adjustments each need the right authorities in the articles and resolutions. 

• Check tax reliefs first: Anti-dilution rights can put EIS and SEIS relief at risk, because qualifying shares must not carry preferential rights. 

Few founders plan for a down round, but many companies have one. When a company raises money at a lower price per share than in an earlier round, existing shareholders suffer twice: their percentage falls and so does the value of each share. Anti-dilution protection is how earlier investors seek to protect themselves against the second of those effects. It is one of the most heavily negotiated terms in a venture investment, and one of the least understood. 

This article explains what anti-dilution protection is, how the main formulae work, how the adjustment is delivered under English company law, and why EIS and SEIS investors need to take particular care.

What is the difference between dilution and economic dilution?

From start-ups to established businesses, companies will often go through a series of equity financing rounds with multiple investors. With each round of financing, the company issues new shares to the new investors which in turn reduces the existing shareholders’ ownership percentage of that company. This is referred to as a “share dilution”. 

Every new issue of shares dilutes existing shareholders’ percentage ownership. In an “up round”, where new shares are issued at a higher subscription price than at paid by the investors at the previous round, that dilution is usually acceptable: each existing share is worth more, even though it represents a smaller share of the company. 

In a “down round”, new shares are issued at a lower price than earlier investors paid. Existing shareholders are diluted in percentage terms and in economic terms, because the lower price implies that their shares are worth less. Anti-dilution protection addresses that economic dilution. 

An up round only results in a share dilution. If the company is doing well, each round of investment increases the company’s pre-money valuation for each subsequent funding round which means the value of the shares that are owned by the existing investors also increases and only their ownership percentage of the company may decrease. For this reason, the scale of a share dilution on the existing shareholders (i.e. existing investors) is considered to be insignificant. 

However, if the company is not doing particularly well or as expected, its pre-money valuation may decrease in subsequent rounds of financing which means the down round would not only result in a share dilution, but it will also reduce the economic value of the existing investors’ shares when the new shares are issued to the new investors at a lower subscription price.  This is referred to as an “economic dilution”. Consequently, the dilutive effect of a down round for existing shareholders is much greater because their ownership percentage of the company as well as the value of their shares decrease.

What is an anti-dilution protection?

An anti-dilution protection is a right attached to a class of shares, protecting that class of shareholders from the dilutive effects of a down round to some extent. Founders and early investors often request anti-dilution protection to: 

1. maintain their ownership percentage of the total voting powers and thus retain control of the company; and/or 
2. protect the value of their investment. 

Anti-dilution provisions (also known as “rachet” or “price protection”) are increasingly common in venture capital transactions and they can be found in the articles of association. 

Anti-dilution protection should not be confused with pre-emption. Statutory pre-emption rights require a company to offer new ordinary shares issued for cash to existing shareholders in proportion to their holdings (section 561 of the Companies Act 2006). Pre-emption protects a shareholder’s percentage, but only if they invest again. Private companies can exclude or disapply the pre-emption rights through their articles or by special resolution (Part 17, Chapter 3), and investors usually negotiate their own contractual pre-emption rights instead. 

Please see our insight article for more information on the important components shaping articles of association. 

How is the adjustment delivered?

An anti-dilution right is only as good as the mechanism that delivers it. Under English company law, there are three main routes: 

• Bonus shares. The company issues additional shares to the protected investor, paid up by capitalising its reserves. Under the Model Articles, capitalisation needs the authority of an ordinary resolution (article 36), and bespoke articles commonly provide for it expressly. The statutory pre-emption right does not apply to bonus shares (section 564). 

• Subscription at nominal value. If the company lacks reserves to capitalise, the investor is given the right to subscribe for the additional shares at nominal value. Shares cannot be allotted at a discount to their nominal value (section 580, Part 17), so nominal value is the floor. 

• Adjusting the conversion ratio. Where investors hold preference shares that convert into ordinary shares, the articles can increase the number of ordinary shares each preference share converts into. No new shares are issued until conversion, which makes the adjustment less visible and easier to reverse. 

Whichever route is used, the directors need authority to allot the shares (sections 549 to 551), and any change to the rights of a class of shares must follow the class consent procedure (section 630). These authorities are best put in place at the original investment, rather than in the middle of a difficult down round. 

Anti-dilution methods: bonus issue or adjustment of the conversion rate

An anti-dilution provision is triggered upon the issue or grant of new securities at a down round. The definition of “new securities” is a matter for negotiation between the parties but investors usually accept that share options granted under an employee share scheme and other issues such as issue of shares in connection with certain financings are excluded. 

In an equity financing round, investors are often issued preference shares which have preferential treatment over other shares and carry the right to benefit from an anti-dilution protection. If there is a down round, there are two ways to protect those investors:

1. issue bonus shares; or
2. adjust the conversion rate.   

Bonus Issue

As compensation for the dilution effect on the existing shareholders with anti-dilution protection rights, the company can issue additional shares which may be preferred shares or ordinary shares. In order to make a bonus issue of shares, the company must have certain authorities as well as sufficient distributable profits, quasi-capital funds or non-distributable reserves to pay for the bonus shares. If the company cannot capitalise to fund a bonus issue, then the relevant shareholders normally have the right to subscribe for the additional shares at nominal value.

Adjustment of the conversion rate

As mentioned above, investors usually hold preferred shares which are convertible into ordinary shares for various purposes. Usually, the initial conversion rate is one, meaning each preferred share converts into one ordinary share. If there is a down round, the conversion rate is increased so that each preferred share converts into more than one ordinary share. 

Each of the two methods mentioned above have advantages and disadvantages. For example, issuing bonus shares is preferrable for the founders and investors as they see the effect of the anti-dilution protections immediately upon the increase in their shareholding, however this does very little for the remaining shareholders (particularly employee shareholders) as they feel the brunt of any decrease in the company’s valuation and their immediate dilution is apparent. By comparison, the adjustment of the conversion rate is not very transparent, however it does allow for the anti-dilution process to be easily reversed if needs be, for instance, if the anti-dilution provision is triggered upon grant of options, but the options are never exercised. 

How do full ratchet and weighted average protection work?

As well as the method you choose to incorporate into your anti-dilution provision, you also need to decide what level of protection should be afforded. Broadly speaking, there are two levels of protections: full ratchet and weighted average. The latter is subdivided into narrow-based and broad-based weighted average. Consider an investor who paid £2 a share for 200 shares, an investment of £400. The company later issues 200,000 new shares at £1 a share, raising £200,000. Before the down round, the company had 1,000,000 shares on a fully diluted basis. 

• Full ratchet. The investor’s price is reset to the new price, as if they had invested at £1. Their £400 now buys 400 shares, so they receive 200 additional shares. The amount raised in the down round is irrelevant: a small issue at a low price triggers the same adjustment as a large one. That makes a full ratchet highly dilutive for founders and employees, and it can deter future investors. As an alternative, you may want to consider replacing the full ratchet protection with one of the two weighted average approaches upon the achievement of certain milestones or performance objectives. 

• Weighted average. The adjusted price takes account of how many new shares are issued. A common broad-based formula is: new price = old price × (A + B) ÷ (A + C), where A is the number of shares in issue before the down round, B is the number of shares the new money would have bought at the old price and C is the number of new shares actually issued. Here, the adjusted price is £2 × 1,100,000 ÷ 1,200,000, or about £1.83. The investor’s £400 now buys about 218 shares, an additional 18. 

A “narrow-based” formula uses a smaller figure for A, takes into account the issued share capital of the company and typically excludes certain categories of securities from it whereas the “broad-based” encompasses all outstanding shares on a fully diluted basis, thereby includes all outstanding warrants, options, and convertible shares. This produces a larger adjustment, which is why investors prefer it and founders resist it. Some agreements start with a full ratchet and convert to a weighted average after a period or once milestones are met. 

Unlike the full ratchet, weighted average does allow the relevant investors’ percentage ownership to be diluted to some extent, but it also provides them with some compensation whilst also limiting the impact of the dilutive financing events on the company’s founders and existing shareholders. Therefore, it is the favoured approach and considered to be much fairer than the full ratchet. 

Does anti-dilution protection affect EIS and SEIS relief?

It can, and the risk should be assessed before the investment documents are agreed. To qualify for EIS relief, the shares must be ordinary shares that, throughout the qualifying period, carry no present or future preferential right to the company’s assets on a winding up, no present or future right to be redeemed and no preferential right to dividends of the kinds described in section 173(2A) of the Income Tax Act 2007. HMRC’s guidance explains that a right is preferential if it takes priority over a right carried by another share (VCM12020). Similar requirements apply under SEIS (VCM33020). 

A right to receive additional shares in a down round, which other shareholders do not enjoy, sits uneasily with those requirements. Because the condition applies to “future” rights, a protection that would only operate in a later down round can still affect relief from the outset. In practice, EIS and SEIS investors usually invest on the same terms as founders without anti-dilution protection, and companies raising money from both EIS and other investors often put the investors in separate classes. Where there is any doubt, the company should seek HMRC advance assurance on the actual articles before shares are issued. See our article on raising investment in the UK. 

What should founders and investors negotiate?

For investors, anti-dilution protection is a hedge against overpaying in the first round. For founders, it shifts the cost of a down round onto everyone else, including employees whose options may already be underwater. A weighted average formula, sensible exclusions, a majority waiver and pay-to-play usually produce a balanced outcome. In any down round, the directors must also act in the way they consider most likely to promote the success of the company for the benefit of its members as a whole (section 172), and a fair process matters if any shareholder later complains of unfair prejudice. 

Anti-dilution protection: a practical checklist 

When agreeing anti-dilution protection, founders and investors are likely to need to consider: 

• Formula. Full ratchet, broad-based or narrow-based weighted average, and whether the formula changes over time. 

• Definition. What counts as a new issue and which issues are excluded. 

• Mechanism. Bonus issue, subscription at nominal value or conversion adjustment, and whether the articles and resolutions support it. 

• Waiver. Whether an investor majority can waive protection for all investors. 

• Pay-to-play. Whether protection depends on investing in the down round. 

• Tax reliefs. The effect on EIS or SEIS relief, and whether to seek advance assurance. 

• Interaction. How protection works alongside pre-emption rights and liquidation preferences. 

At Maybrook Law, we advise founders and investors on venture investments, including anti-dilution protection, liquidation preferences and down rounds. We focus on terms that work for the company’s next round as well as this one. If you are negotiating an investment or facing a down round, we would be pleased to advise on your position. 

This article reflects the law as at 16 June 2026. Our insights, articles and guides do not, and are not intended to, constitute legal advice or be an exhaustive review of all legal developments. Although every effort is made to ensure that the information provided in this article is accurate as of the publication date, please be aware that this area of law may be subject to change. Please seek legal advice before applying the information provided to any specific circumstances, transactions or legal issues.