A provision that adjusts investors' conversion ratio if the company later raises money at a lower valuation, protecting their effective ownership.
Anti-dilution provisions protect investors if the company raises a "down round" — a new financing at a lower valuation per share than the investor paid. Without protection, the investor's percentage ownership would shrink significantly. Anti-dilution provisions adjust the conversion price (the price at which preferred stock converts to common stock), giving investors more common shares than their original investment would have provided.
The two main types are broad-based weighted average (the most common and founder-friendly) and full ratchet (the most aggressive and investor-friendly). With full ratchet, the investor's conversion price is adjusted all the way down to the new lower price, regardless of the size of the down round. With weighted average, the adjustment is proportional and less severe.
Anti-dilution provisions are a standard part of preferred stock in Series A and later rounds. They rarely come into play in successful companies, but in a down round they can significantly dilute founders and employees while protecting investors. Understanding the type of anti-dilution protection you're granting is an important part of reviewing any term sheet.