Mission Briefing
Vegi had read the term sheet three times. His lawyer had read it twice. Everyone agreed it looked standard. It was standard. Full-ratchet anti-dilution was a standard provision. The issue was that nobody had explained what it actually did. When the down round closed two years later, Vegi owned 9% of a company he had started from his kitchen. He had owned 31% the week before the round. This issue is about the clause that made that possible.
Venture Odyssey
Departure
: The round everyone wanted to be in
Vegi is from the Vega system, which is the fifth-brightest star in the night sky and has approximately twice the mass of Earth's sun. People from Vega tend to have a similar relationship with scale. When Vegi built things, he built them big. When he raised money, he raised it confidently. When his Series A came in at a $22M valuation with $4.5M from a lead investor and a set of terms that his lawyer called clean, he felt the specific satisfaction of a person who had done everything right.
Reti had led the round. Reti was from Zeta Reticuli, always smiling, too many teeth. His briefcase contained term sheets with small red flags printed on them in a font that was easy to overlook if you were looking at the valuation and the structure and the lead investor's track record instead of the flags. Reti's track record was real. His portfolio companies had exited. His references checked out. He was, by every measure Vegi applied, a good investor.
The term sheet was forty-one pages. The economics were on pages two through six. Everyone read pages two through six carefully. Everyone felt good about pages two through six.
Schedule B was on page thirty-seven.
Vegi's lawyer flagged it briefly. "Anti-dilution provision, full ratchet. Standard for this stage and this investor. It's a protective mechanism for the investor in case of a down round." Vegi nodded. They had agreed not to do a down round. The projections showed 40% year-over-year growth. The down round scenario was theoretical. They moved on.
The term sheet closed. The money landed. Vegi built.
Layover
: The year the market turned
Eighteen months into the Series A, the market did what markets do with no warning and no apology. The sector Vegi operated in contracted sharply. Three of his largest customers delayed renewals. His monthly revenue went from growing at 12% to flat, and then to declining at 7%. The burn rate that had felt responsible at $22M started feeling heavy at a valuation that no longer made narrative sense.
He needed a bridge round. The conversation with Reti started well. Reti was supportive. He wanted to protect his investment. The bridge terms he proposed were clean. $1.5M at a $9M pre-money valuation.
Vegi's finance person had modelled the dilution on the bridge. At $9M, the new shares would be issued at a price significantly below the Series A. That meant Vegi would be diluted. He modelled that dilution at approximately 12 percentage points, painful but survivable. He owned 31% before the bridge. He expected to own roughly 19% after.
He told his co-founder. His co-founder said they had no choice. Vegi signed the bridge term sheet.
The lawyer called him the following week. Not his regular lawyer. A startup specialist who had been brought in to review the bridge documents. She had spent six hours with the Series A term sheet and the bridge term sheet side by side.
"I need to walk you through something," she said.
"The anti-dilution."
"Yes."
This is what full-ratchet anti-dilution means. When a company raises a new round at a price per share lower than the price at which an existing investor bought in, that existing investor is entitled to have their ownership percentage recalculated as if they had paid the lower price from the beginning. Not a partial adjustment. A full recalculation. Every share they bought is retroactively repriced at the new lower price, which means they receive additional shares to make up the difference, which means everyone else is diluted by the number of additional shares created.
Full ratchet is the most aggressive version of anti-dilution. The alternative is weighted average, which spreads the adjustment across the size of the down round and produces a smaller dilution impact for existing shareholders. Most late-stage investors accept weighted average. Full ratchet is less common, but it appears, and when it appears, it hides in Schedule B.
The bridge was at $9M. The Series A had been at $22M. Reti's fund had invested $4.5M at the $22M valuation. The full-ratchet provision meant they were entitled to receive additional shares equivalent to what they would have received if they had invested at the $9M price instead. The number of additional shares created was large. The dilution to Vegi was not 12 percentage points.
It was 22.
"I own 9%," Vegi said, when the lawyer finished explaining.
"After the bridge closes, yes. Approximately."
"I owned 31% last week."
"Yes."
There was a silence on the call that lasted about fifteen seconds. Vegi was not a person who stayed quiet for fifteen seconds.
"Was this in the documents?"
"It was in Schedule B of the Series A term sheet. It was described accurately. The math was always going to work this way."
"Did anyone explain this to me?"
The lawyer paused for a long moment. Not because the answer was complicated. Because the answer was simple in a way that required some care to deliver.
"The term sheet described it as an anti-dilution protection mechanism for the investor in case of a down round," she said finally. "Which is accurate. What it did not walk you through is the specific arithmetic of what full ratchet versus weighted average produces in a scenario like this one."
"My lawyer at the time said it was standard."
"It is a real provision. Whether it is standard depends on what market you are in, what stage you are at, and whether you had the leverage to negotiate it at the time. At Series A, from this investor, at that moment in the market, it may well have been the starting position. Whether it was the ending position is a different question."
Vegi did not say anything else on the call. He thanked the lawyer and hung up. He sat in his office in the building he had moved into with Series A money and looked at the window for a while.
He called me that evening. I was in Barcelona, between meetings, and his name came up on my phone and I answered because I had worked with him before and I knew when something was wrong from the first word.
"Tell me about full ratchet," he said.
I told him. He already knew. He wanted to hear it from someone who was not on his legal team. When I finished, he said: "Is there anything to do now?"
The honest answer was: not much. The documents were signed. The bridge was closing. The dilution was contractual. The path from here was building the company back up, which was always the only real path, but it would now be building it from 9% instead of 31%.
"Next time," I said, "you negotiate weighted average. You walk away from full ratchet if you have any leverage at all. And if you don't have the leverage to remove it, you model the down round before you sign, not after."
Arrival
: The math that was always going to land there
Here is what no term sheet summary ever says directly: anti-dilution provisions are not for you. They protect the investor from the consequences of a round that goes wrong. Which is a reasonable thing to want protection from. The question is which version of protection you agree to, and what it costs you in the scenario nobody is planning for.
Full ratchet is the nuclear version. Weighted average is the negotiated version. Broad-based weighted average is the most founder-friendly standard form. The difference between them, in a down round of any meaningful size, can be ten, fifteen, twenty percentage points of founder ownership.
Think of it like a loan with a penalty clause. You borrow money and agree that if you miss a payment, the penalty is 5% of the loan. That is weighted average territory, proportionate and recoverable. Full ratchet is agreeing that if you miss any payment, the lender gets to recalculate the entire loan at the penalty rate, retroactively. The number that comes back is always larger than the one you had in your head when you signed.
Vegi's company survived the bridge. He built it back. He raised a Series B at a higher valuation, which partially restored his ownership through anti-dilution mechanics running in reverse. He stayed the CEO. He still runs the company today.
But he now reads Schedule B before he reads pages two through six. And he models the down round scenario before he decides whether the term sheet is standard.
Check the schedule. Every time. Before you decide the math is theoretical.
Three things to do this week
Find the anti-dilution provision in every term sheet you have signed or are reviewing. Usually in a section titled "Anti-Dilution" or buried in the definitions of preferred share rights. Identify whether it says "full ratchet" or "weighted average" and which weighted average formula applies. Done looks like: a highlighted copy of the relevant clause with the type labelled, before you agree to anything else.
Model a down round before you close any round. Take your current post-money valuation, cut it by 40%, and run the anti-dilution math. If the provision is full ratchet, calculate how many additional shares the investor receives. Calculate what happens to your ownership percentage. Done looks like: a spreadsheet showing founder ownership before and after a hypothetical 40% down round for each investor with anti-dilution rights.
Negotiate for broad-based weighted average as your baseline position. Full ratchet is aggressive and uncommon among founder-friendly investors. If a term sheet contains full ratchet, ask for weighted average. If the investor will not move, ask yourself what the leverage balance is and whether you have alternatives. Done looks like: your signed term sheet contains weighted average or a written explanation of why you accepted full ratchet.
Curious Corner
Brad Feld and Jason Mendelson: Venture Deals : The most thorough plain-language explanation of venture term sheets written for founders. Chapter 8 covers anti-dilution in full, including the weighted average formulas and worked examples showing the founder dilution under each scenario.
NVCA Investor Rights Agreement Model : The model investor rights agreement contains the standard broad-based weighted average anti-dilution provision that most professional investors accept as a starting point. If your term sheet varies from this model significantly, you should understand why before you sign.
The Free Resource
The Anti-Dilution Clause Decoder. Paste any anti-dilution clause and see what it actually does to your ownership in a down round. Full-ratchet vs weighted-average vs broad-based, explained in plain English with the math walked out.
The Question
Have you ever read the full term sheet you signed, including the schedules, before you closed? Not the summary your lawyer sent. The actual document, every page. If you found something in the back that you had not expected, I want to know what it was and how you handled it. If you have never read past page ten of a term sheet in your life, you are also in a significant majority. Hit reply.
Writing this from Barcelona, where I just spent two hours on a call walking a founder through a term sheet clause that his lead investor described as "totally standard," which it is, in the same way that a penalty kick is standard in football. You know what it does. You just do not want to be on the wrong side of it. Next issue: what happens to your money when a $50M exit lands and the liquidation preference stack goes first.
Read the schedule. Every schedule. Even the ones that look like footnotes.
Pepe
The Outlaw Chronicles is for education only. Nothing here is legal advice. For the real thing, you know where to find me.