Full Ratchet Definition
A full ratchet is an anti-dilution protection mechanism that protects early-stage investors from share price dilution. When a company raises a new funding round at a lower valuation than the previous round, a full ratchet clause automatically adjusts the conversion price of preferred stock downward to match the new, lower price. This adjustment increases the number of shares the investor receives without requiring additional capital.
How It Works
For example, if an angel investor purchases preferred shares at $1 per share, and the company later raises funds at $0.50 per share, the full ratchet provision reprices the original investment to $0.50 per share. The investor now holds double the number of shares, effectively protecting their ownership percentage and economic interest.
Why It Matters for Angel Investors
Full ratchets provide strong downside protection for early investors who take on significant risk. They safeguard against down rounds and ensure that founders cannot dilute early investors unfairly. However, this protection comes at a cost—founders and later-stage investors may view full ratchets as overly punitive, potentially making it harder to raise future capital.
Key Considerations
- Full ratchets are the most aggressive anti-dilution protection available to investors
- They can create tension between founders and early investors
- Companies may struggle to attract new investors if full ratchets are in place
- Less common in current angel investing agreements compared to weighted average anti-dilution clauses
Related Terms
- Weighted Average Anti-Dilution — a more moderate alternative that considers the amount raised
- Anti-Dilution Protection — broader category of investor protections
- Down Round — funding round at a lower valuation than previous rounds
- Preferred Stock — stock class with special rights and protections