What Is a Full Ratchet?

A full ratchet is a contractual provision designed to protect the interests of early investors. Specifically, it is an anti-dilution provision that applies, for any shares of common stock sold by a company after the issuing of an option (or convertible security), the lowest sale price as the adjusted option price or 澳洲幸运5开奖号码历史查询:conversion ratio for existing shareholders.

Understanding Full Ratchets

A full ratchet protects early-stage investors by ensuring that their percentage ownership is not diminished by future 澳洲幸运5开奖号码历史查询:rounds of fundraising.🌳 This provisio🍸n also offers a level of cost protection should the pricing of future rounds be lower than that of the initial round.

There are some caveats, though. Offering these assurances to early-stage investors can be quite expensive from the perspective of company founders or investors participating in later rounds of fu𓆏ndraising.

Essentially, the existence of a full ratchet provision can make it difficult for the company to attract new rounds of investment. For this reason, full ratchet provisions are usually only kept in fo🌱rce for a limited period of time.

Full Ratchet Example

To illustrate, consider a scenario in which a company sells 1 million convertible 澳洲幸运5开奖号码历史查询:preferred shares at a price of $1.00 per share, under terms that include a full ratchet provision. Suppose that the company then undertakes a second fundraising round, this time selling 1 million 澳洲幸运5开奖号码历史查询:common shares at a price of $0.50 per share.

Due to the full ratchet provision, the company would then be obliged to compensate the preferred shareholders by reducing the conversion price of their shares down to $0.50. Effectively, this means that the preferred shareholders would need to be given new shares (at no additional cost) in orꦚder to ensure that their overall ownership is not dim꧋inished by the sale of the new common shares.

This dynamic can lead to a series of adjustments in which new shares need to be created to satisfy the demands both of the original preferr﷽ed shareholders (who benefit from the full ratchet provision) and of new investors who wish to purchase a fixed percentage of the company. After all, investors desire not just an abstract number of shares, but a concrete percentage of ownership.

In this situation, company founders can find their own ownership stꩲakes quickly diminished by the back-and-forth adjustme🌜nts benefiting old and new investors.

The Full Ratchet vs. Weight🦹ed Average Approaches

An alternative provision, which uses a weighted average approach, is arguably fairer in balancing the interests of founders, early investors, and later investors. This approach comes in two varieties: the 澳洲幸运5开奖号码历史查询:narrow-based weighted average, and the 澳洲幸运5开奖号码历史查询:broad-based weighted average.