What is a Full Ratchet?

A full ratchet anti-dilution provision, often referred to simply as a full ratchet, is a mechanism by which the ownership stake of an investor in a company is protected from being diluted by the issuance of additional shares in later rounds of financing.

Example of a full ratchet

Say an equity investor has shares of stock that give them 10% of the company.


If the company embarks on a later round of financing by issuing more shares, the investor with a full ratchet anti-dilution clause in their agreement could convert their shares into a larger number of shares without investing any additional money. They’d receive enough stock to still own 10% of the company.


Here is a more detailed example. Say an investor owns 10,000 shares out of 100,000 total outstanding shares issued by a small startup (that is, 10%).


If the shares have a market value of $5, the investor has a stake worth $50,000 in a company with a market value of $500,000.


Now imagine that the startup founders embark on a new round of financing and issue another 100,000 shares. Without full ratchet anti-dilution in place, this investor would then have just their original 10,000 out of the new total of 200,000 shares. Their ownership stake would diminish to 5%, which is half as much as it used to be.


However, with a full ratchet provision, the investor could convert their existing shares into a number of shares that brings them back to a 10% ownership stake. In this case, they would end up with 20,000 shares, which, assuming the same $5 per share, would be worth $100,000.


If this later round had been priced lower, say $2, they would be issued even more stock to maintain their 10% ownership.


Ultimately, that’s what “ratchet” refers to: the price of a share for an investor with anti-dilution protection.

Implications for investors

Generally speaking, a full ratchet represents a beneficial deal for investors, because it allows them to hold more shares at no extra cost.


That advantage is even greater if additional rounds of financing issue shares at a higher price, as these shares would convert for the investors at a discount.


But short-term financial gain isn’t the only advantage offered. Owning a certain percentage of shares can give investors who hold preferred stock voting rights, and with that, a voice in the direction of the company.


Without full ratchet protection, an investor with voting rights would need to buy more stock to retain their voting rights, or else, settle for being demoted to a non-voting investor as more and more investors come to own shares.

Implications for investors

Generally speaking, a full ratchet represents a beneficial deal for investors, because it allows them to hold more shares at no extra cost.


That advantage is even greater if additional rounds of financing issue shares at a higher price, as these shares would convert for the investors at a discount.


But short-term financial gain isn’t the only advantage offered. Owning a certain percentage of shares can give investors who hold preferred stock voting rights, and with that, a voice in the direction of the company.


Without full ratchet protection, an investor with voting rights would need to buy more stock to retain their voting rights, or else, settle for being demoted to a non-voting investor as more and more investors come to own shares.

Implications for founders, company owners, and later investors

Ratchet provisions have some notable disadvantages for founders or owners of a company and later investors who have not been offered a full ratchet.


Namely, having a group of investors whose shares cannot be diluted means that the ownership stake of the founders and subsequent investors will be diluted as more shares are issued.


In the worst-case scenario, founders could lose all control of their own company.


So why would founders offer a ratchet provision? It’s a tradeoff to secure financing in the first place. It offers key early investors assurance and protection in exchange for their bet on the company as it tries to grow.


This protection can be especially necessary to early investors if they doubt the company’s valuation, or projected growth.

Plus, there are ways for founders to mitigate their risk, such as using a weighted average share price for the ratchet conversion or limiting how many times equity investors can exercise their right to convert shares.