Learn how to protect your VC investment from dilution in a down round with these tips on negotiating anti-dilution provisions.

Why should they? Seriously? Why is money protected over sweat, anxiety, effort, and knowledge? I see no reason to protect capital. I see every reason to protect people. 90~95% of the reasons for a down round are exogenous to the management of the business. Some are “baked in” by over aggressive or over enthusiastic investors. I see no good reason for anti dilution provisions for professional investors. Sorry. Now let’s talk about the hundreds of hugely talented first time founders who watched their “investors” take the whole exit value through preferences and ratchets, leaving them with pennies after a decade of dedication.

What are the best ways to negotiate a favorable anti-dilution provision for VCs?

Anti-dilution provisions are clauses in VC term sheets that protect investors from losing their ownership percentage when a startup raises more money at a lower valuation than before. This is also known as a down round. As a VC, you want to negotiate a favorable anti-dilution provision that minimizes your dilution and maximizes your returns. But how do you do that? Here are some tips to help you.

1 Understand the types

There are two main types of anti-dilution provisions: full ratchet and weighted average. Full ratchet is the most favorable for VCs, as it allows them to adjust their conversion price to the lowest price paid by any new investor in a down round. This means they can keep their original share of the company, regardless of how much the valuation drops. Weighted average is more common and more fair, as it adjusts the conversion price based on the average price paid by all investors in a down round, weighted by the amount of money raised. This means that VCs still get diluted, but less than they would without any anti-dilution protection.

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David John William Bailey, FCA IFT

Helping founders and investors through crises and turnarounds into growth businesses with successful exits with actionable financial strategy and trustworthy insights.
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Why should they? Seriously? Why is money protected over sweat, anxiety, effort, and knowledge? I see no reason to protect capital. I see every reason to protect people. 90~95% of the reasons for a down round are exogenous to the management of the business. Some are “baked in” by over aggressive or over enthusiastic investors. I see no good reason for anti dilution provisions for professional investors. Sorry. Now let’s talk about the hundreds of hugely talented first time founders who watched their “investors” take the whole exit value through preferences and ratchets, leaving them with pennies after a decade of dedication.

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2 Know the market

Before you enter a negotiation, you should do your homework and research the market conditions and trends for your industry and stage. You should also compare the terms of similar deals and understand the valuation and dilution expectations of both sides. This will help you gauge how realistic and reasonable your anti-dilution provision is, and how much leverage you have to negotiate.

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3 Be flexible and creative

While you may have a preference for a certain type of anti-dilution provision, you should also be open to alternatives and compromises that can achieve a similar outcome. For example, you can offer a lower valuation in exchange for a full ratchet, or a higher valuation in exchange for a weighted average. You can also use other terms, such as dividends, liquidation preferences, or warrants, to balance the effects of dilution. The key is to find a solution that aligns the interests of both parties and preserves the relationship.

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4 Communicate clearly and honestly

One of the most important skills in any negotiation is communication. You should communicate clearly and honestly with the founders and other investors about your expectations, rationale, and goals for the anti-dilution provision. You should also listen to their feedback and concerns, and address them respectfully and constructively. By doing so, you can avoid misunderstandings, conflicts, and resentment, and build trust and rapport.

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5 Seek professional advice

Negotiating a favorable anti-dilution provision can be complex and challenging, especially if you are new to VC or dealing with a high-stakes deal. Therefore, it is advisable to seek professional advice from lawyers, accountants, or mentors who have experience and expertise in this field. They can help you understand the legal and financial implications of different scenarios, draft and review the term sheet, and guide you through the negotiation process.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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What are the best ways to negotiate a favorable anti-dilution provision for VCs?

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1 Understand the types

2 Know the market

3 Be flexible and creative

4 Communicate clearly and honestly

5 Seek professional advice

6 Here’s what else to consider

Venture Capital

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What are the best ways to negotiate a favorable anti-dilution provision for VCs?

1

2

3

4

5

6

1 Understand the types

2 Know the market

3 Be flexible and creative

4 Communicate clearly and honestly

5 Seek professional advice

6 Here’s what else to consider

Venture Capital

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