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Full Ratchet

Anti-dilution protection resetting preferred stock conversion price to the lowest price of any subsequent share issuance.

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FAQs

Why is full ratchet considered founder-unfriendly?

Full ratchet is founder-unfriendly because it allows a single share issued in a down round at any price to reset the conversion price of all previously issued preferred stock to that price, massively increasing the number of shares investors receive upon conversion. This extreme dilution severely reduces founder and employee ownership percentages, can create structural incentive problems (founders may have little equity left to motivate them), and can make the company unattractive to new investors who see an existing investor with full ratchet rights taking most of the equity in a turnaround scenario.

How does full ratchet differ from weighted average anti-dilution?

Full ratchet resets the conversion price entirely to the new lower price regardless of how many shares are issued. Weighted average anti-dilution adjusts the conversion price based on a formula that weights both the new lower price and the number of new shares issued relative to existing shares. Weighted average produces a much smaller conversion price adjustment when the down-round issuance is small, and only fully resets to the new price if an extraordinarily large number of shares are issued. This makes weighted average far less punishing for founders and common stockholders in typical down-round scenarios.

In what situations might full ratchet be acceptable to founders?

Full ratchet provisions might be acceptable when a company is in a distressed situation and needs capital from an investor who insists on full protection, when the investment size is small and the risk of triggering the provision is considered low (bridge financing), when the company and founders have significant leverage and negotiated other extremely favorable terms in exchange for accepting full ratchet, or when the founders believe strongly that no down round will occur. In practice, experienced startup counsel typically advises against accepting full ratchet under any normal circumstances.

Related Terms

Ratchet

Mechanism adjusting investor ownership percentage upward if performance targets are missed post-investment.

Weighted Average Anti-Dilution

Anti-dilution adjustment formula balancing down-round share price with the volume of new shares issued.

Participating Preferred

Preferred stock that receives its liquidation preference and also participates in remaining proceeds alongside common stockholders.

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Full ratchet is the most aggressive form of anti-dilution protection available to preferred stockholders in venture capital and private equity transactions. Under full ratchet anti-dilution, if a company issues new shares at a price lower than the original preferred stock purchase price (a 'down round'), the conversion price of the existing preferred stock is reset to the new, lower price—regardless of how many shares are issued at that price.

The impact of full ratchet is severe for founders and common stockholders. Even a single share sold at a lower price triggers the full reset. If investors originally paid $10/share and a new investor buys one share at $1/share, the original investors' conversion price resets to $1/share—dramatically increasing the number of common shares they will receive upon conversion and massively diluting everyone else.

Full ratchet anti-dilution is considered very investor-friendly and is relatively uncommon in modern venture capital—it was more prevalent in the era of corporate venture and bridge financing in the 1990s and early 2000s. Most contemporary VC term sheets use weighted average anti-dilution instead, which more moderately adjusts the conversion price based on both the price and quantity of new shares issued.

Founders and employee option holders bear the most severe dilution from full ratchet provisions because their equity does not receive anti-dilution protection. For this reason, company-friendly term sheets explicitly exclude full ratchet, and founder-favorable term sheet provisions from organizations like the NVCA standardize on broad-based weighted average anti-dilution.

Some full ratchet provisions include a 'carve-out' exempting certain issuances—employee option pool expansions, convertible debt conversions—from triggering the ratchet.