A type of anti-dilution mechanism. A weighted average ratchet adjusts downward the price per share of the preferred stock of investor A due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received. Investor A's preferred stock is repriced to a weighed average of investor A's price and investor B's price. A narrow-based ratchet uses only common stock outstanding in the denominator of the formula for determining the new weighed average price. Compare Broad-Based Weighted Average Ratchet and Chapter 2.9.4.d.ii of the Encyclopedia for specific examples.

A narrow-based weighted average is an anti-dilution provision used to ensure that investors are not penalized when companies are undergoing additional financing or issuing new shares. It takes into account only the total number of outstanding preferred shares for determining the new weighted average price for the old shares.

Dilution occurs when a company issues new stock to raise capital. When the number of shares outstanding increases, each existing stockholder ends up owning a smaller, or diluted, percentage of the company, making each share less valuable.

Anti-dilution provisions such as a narrow-based weighted average help to prevent this from happening. If a company sells more shares at a lower price, the dilution protection provision will make a downward adjustment in the conversion price of the convertible securities. Consequently, upon conversion, existing investors would receive more shares of the company, thereby allowing them to maintain their original stake in the company as a percentage of the company's shares.

The narrow-based weighted average might be an aspect of the negotiated terms for later funding rounds for a venture capital company as more shares are issued and valuations increase. The intent is to safeguard the ownership stake that was granted to early shareholders as more funding rounds stand to further dilute shares and potentially weaken their ownership in the company.