Full ratchet anti-dilution is a protective provision in convertible securities that adjusts an investor's conversion price downward to match the price of any subsequent financing round that occurs at a lower valuation, regardless of how much capital is raised at that lower price. This mechanism ensures that early investors can convert their preferred shares into common stock as if they had originally invested at the lower price, protecting them from dilution in down rounds.
Why It Matters
Full ratchet provisions represent the most investor-friendly form of anti-dilution protection and can have severe consequences for founders and common shareholders. When triggered, they transfer substantial equity value from founders and employees to protected investors, potentially reducing founder ownership by 10-30% or more in a significant down round. Understanding these provisions is essential because they signal the power dynamics in a deal and can discourage future investors who know they'll bear the full burden of dilution if their round prices below previous rounds.
Example
An angel investor puts $500,000 into a startup at $1.00 per share with full ratchet protection, purchasing 500,000 preferred shares. Two years later, the company struggles and raises a bridge round at $0.25 per share. Under full ratchet anti-dilution, the angel's conversion price resets to $0.25, meaning their $500,000 investment now converts to 2,000,000 shares instead of the original 500,000. The company must authorize an additional 1,500,000 shares for the angel, which dilutes founders and employees proportionally. If founders owned 60% before the adjustment, they might see their stake drop to 45% without investing additional capital, while the angel's percentage ownership increases dramatically despite the company's declining value.
Related Terms
Weighted Average Anti-Dilution, Down Round, Conversion Price