What it means
When a company raises money at a lower price per share than a previous round, that is a down round, and it hurts the investors who paid the higher price. Anti-dilution clauses exist to compensate them, and broad-based weighted average is the version most investors and founders end up agreeing to.
The mechanic is a conversion price adjustment rather than a gift of new shares. The earlier investor keeps exactly the same number of preferred shares, but each one now converts into more than one ordinary share, which lifts their percentage of the company without any cash changing hands.
The words broad-based describe what goes into the share count used in the formula. A broad base includes ordinary shares, preferred shares counted as if converted, and usually all outstanding options, warrants and shares reserved in the option pool.
A narrow base leaves most of that out, which makes the adjustment larger and considerably more painful for founders and employees. At the harsh end sits the full ratchet, which simply resets the old conversion price to the new lower price no matter how few shares were sold.
Weighted average is gentler because it scales the adjustment to how much cheap stock was actually issued, so a small bridge round barely moves the conversion price at all. Founders should also read the carve-outs, which are usually longer than the clause itself.
Shares issued to employees under an approved option pool, to lenders as warrants, or as consideration in an acquisition are typically excluded, so not every new share triggers an adjustment.
In practice
Real-world examples.
Example
A business software startup raised its Series A at $4.00 a share against 4,000,000 fully diluted shares, then 18 months later took a $2,000,000 bridge at $2.00. Because the Series A carried broad-based weighted average protection, the conversion price fell only from $4.00 to $3.60, giving the earlier investor about 11% more shares on conversion instead of a doubling.
Example
A consumer hardware founder negotiating a Series A was asked to accept narrow-based weighted average, which would have excluded the 2,000,000-share option pool from the share count. She pushed back and secured broad-based instead, on the argument that including the pool made any future adjustment materially smaller for the team.
Example
A biotech's Series B investor held full ratchet protection rather than weighted average. When the company raised a small bridge at half the Series B price, the ratchet halved the conversion price on the entire Series B holding, and the founders lost several percentage points of ownership that a broad-based weighted average clause would have left untouched.
Formula
Calculation
New conversion price = Old conversion price x (A + B) / (A + C)
Here A is the fully diluted shares outstanding immediately before the new issue, B is the number of shares the new money would have bought at the old price, and C is the number of shares actually issued in the new round.
A Series A investor bought preferred shares at $2.00 each and holds 1,000,000 of them. Before the new round the company has 10,000,000 shares on a broad, fully diluted basis, so A = 10,000,000. The company now raises $2,000,000 by selling shares at $1.00 each, so C = $2,000,000 / $1.00 = 2,000,000 shares.
B is what that money would have bought at the old price: $2,000,000 / $2.00 = 1,000,000 shares.
New conversion price = $2.00 x (10,000,000 + 1,000,000) / (10,000,000 + 2,000,000) = $2.00 x 11,000,000 / 12,000,000 = $1.83 when rounded to the cent.
The investor's conversion ratio becomes $2.00 / $1.83 = 1.09, so their 1,000,000 preferred shares now convert into 1,090,909 ordinary shares rather than 1,000,000, an extra 90,909 shares. Under a full ratchet the conversion price would have dropped all the way to $1.00 and the same holding would convert into 2,000,000 shares, which shows how much milder the weighted average outcome is.Case study
Seen in the real world.
Ferrofield Robotics is an illustrative company created to show the arithmetic in context. It raised a Series A of $6,000,000 at $3.00 a share, issuing 2,000,000 preferred shares, and by the time it needed more money it had 12,000,000 shares outstanding on a fully diluted, broad basis.
The follow-on round came in at $1.50 a share for $3,000,000, so the company issued 2,000,000 new shares. Applying the formula, B was $3,000,000 / $3.00 = 1,000,000 shares, and the new conversion price was $3.00 x 13,000,000 / 14,000,000 = $2.79. The Series A investor's 2,000,000 preferred shares would convert into 2,153,846 ordinary shares, an extra 153,846 shares.
The founders had originally been offered a full ratchet in the Series A term sheet. Under that clause the conversion price would have fallen to $1.50 and the Series A would have converted into 4,000,000 shares, doubling the investor's position. The fictional board's view afterwards was that one negotiated word, broad-based, had been worth roughly 1,850,000 shares to the founding team.
Watch out
Common mistakes.
- Thinking anti-dilution protects against ordinary dilution from raising more money, when it only bites when new shares are issued below the earlier price.
- Treating broad-based and narrow-based as interchangeable drafting styles, when the choice of share base can change the adjustment by a factor of several times.
- Forgetting that the adjustment dilutes the founders and the option pool, not the incoming investor, so the people who suffer most are usually the ones still running the company.
Questions
People also ask.
Does the investor receive new shares when this clause is triggered?
No, they keep the same preferred shares, but the conversion price falls so that each preferred share converts into more ordinary shares later.
Why do investors accept weighted average instead of a full ratchet?
Because a full ratchet can demoralise founders and staff so badly after a modest down round that it damages the very company the investor is trying to protect.
What counts as the broad base in practice?
The definition is written into the charter, but it normally includes ordinary shares, all preferred shares on an as-converted basis, and outstanding options, warrants and reserved pool shares.
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