What are Anti-Dilution Ratchets?
Anti-Dilution Ratchets are contractual mechanisms designed to protect early-stage investors from dilution if a company issues new shares at a lower valuation than the price they initially paid. These clauses adjust the price at which earlier investors convert their preferred shares into common stock.
Types of Ratchets
Full Ratchet: Adjusts the conversion price of earlier investors’ shares to match the new, lower share price.
Weighted Average Ratchet: Adjusts the conversion price based on the number of new shares issued and their price relative to existing shares.
Example
An early investor purchases shares at $5 per share. Later, the company issues shares at $3 per share. A full ratchet provision would allow the initial investor to adjust their price to $3 per share for conversion purposes.
Importance
Protects investor equity value in down rounds.
Can affect founder and employee ownership dilution.
Often a key negotiation point in venture financing rounds.