Full ratchet anti-dilution protection adjusts an investor's conversion price to the lowest price at which the company subsequently issues shares, regardless of how many shares are involved. This provides maximum investor protection but can severely impact founders and common stockholders during down rounds.
Full ratchet is the most aggressive form of anti-dilution protection, though rarely used in modern venture capital due to its founder-unfriendly effects.
What is Full Ratchet Anti-Dilution
Full ratchet anti-dilution is a contractual provision in preferred stock or convertible securities that protects investors by adjusting their conversion price to match the lowest subsequent share issuance price. Unlike weighted average formulas that consider down round size, full ratchet applies complete protection based solely on price.
How Full Ratchet Works
The full ratchet mechanism is straightforward: when shares issue below the protected price, the investor's conversion price drops to that new, lower price automatically.
New Conversion Price = Lowest Subsequent Issuance Price
If Series A investors paid $5.00 per share and the company raises at $1.00 per share, the Series A conversion price drops from $5.00 to $1.00. This simplicity makes calculation easy but creates severe consequences.
Conversion Price Adjustment Impact:
| Scenario | Original Price | Down Round Price | Full Ratchet New Price | Result |
|---|---|---|---|---|
| Small down round | $5.00 | $4.00 | $4.00 | 20% reduction |
| Moderate down round | $5.00 | $2.50 | $2.50 | 50% reduction |
| Severe down round | $5.00 | $1.00 | $1.00 | 80% reduction |
Conversion Ratio Recalculation
When full ratchet triggers, the investor's conversion ratio changes. If an investor paid $5.00 per share for 100,000 preferred shares ($500,000 total) and the conversion price drops to $1.00, they now receive 500,000 common shares instead of 100,000.
Conversion Ratio Formula:
New Conversion Ratio = Original Investment Amount ÷ New Conversion Price
Their economic claim remains $500,000, but ownership percentage increases dramatically. A $500,000 investment at $1.00 conversion price yields 500,000 shares (compared to the original 100,000), a 400% increase.
Full Ratchet vs Weighted Average
Full ratchet and weighted average anti-dilution represent opposite ends of the protection spectrum. Most modern venture capital deals use weighted average protection due to its more balanced approach.
Protection Level Comparison
Key Differences:
| Feature | Full Ratchet | Weighted Average |
|---|---|---|
| Adjustment basis | Price only | Price and quantity |
| Protection level | Maximum (100%) | Partial (20-80%) |
| Founder impact | Severe dilution | Moderate dilution |
| Market prevalence | Rare (5% of deals) | Standard (90% of deals) |
Calculation Example:
With 10 million shares outstanding at $5.00/share, followed by a down round of 2 million new shares at $1.00/share:
- Full Ratchet: New conversion price = $1.00 (80% reduction)
- Broad-Based Weighted Average: New conversion price ≈ $4.17 (17% reduction)
Impact on Founders and Employees
Full ratchet concentrates dilution on common shareholders. When preferred investors maintain their economic value through additional shares, founders and employees see their ownership percentages compress significantly.
Ownership Impact Example:
| Stakeholder | Pre-Down Round | Post-Full Ratchet | Post-Weighted Average |
|---|---|---|---|
| Series A Investors | 20% | 45% | 28% |
| Founders | 60% | 30% | 48% |
| Employees | 15% | 8% | 12% |
In severe scenarios, founders can lose majority control despite maintaining their original share count, as the total share pool expands dramatically.
Practical Calculation Example
Consider Startup XYZ before a down round:
Pre-Down Round Cap Table:
| Security Type | Shares | Price Per Share | Investment | Ownership % |
|---|---|---|---|---|
| Common Stock (Founders) | 6,000,000 | $0.001 | $6,000 | 60% |
| Series A Preferred (Full Ratchet) | 2,000,000 | $5.00 | $10,000,000 | 20% |
| Employee Options | 1,500,000 | Various | - | 15% |
The company raises Series B at $1.00 per share, raising $2 million for 2 million shares. This triggers the full ratchet:
- Series A Original Investment: $10,000,000
- Series A New Conversion Price: $1.00
- Series A New Share Count Upon Conversion: $10,000,000 ÷ $1.00 = 10,000,000 shares
Post-Down Round Cap Table (Series A Converted):
| Security Type | Shares | Ownership % | Change |
|---|---|---|---|
| Common Stock (Founders) | 6,000,000 | 31.6% | -28.4% |
| Series A (Converted) | 10,000,000 | 52.6% | +32.6% |
| Employee Options | 1,500,000 | 7.9% | -7.1% |
| Series B Preferred | 2,000,000 | 10.5% | +10.5% |
| Total | 19,000,000 | 100% | - |
For comparison with Weighted Average Protection:
Using broad-based weighted average instead would result in:
- Series A Conversion Price: ~$4.17 (not $1.00)
- Series A Shares Upon Conversion: ~2,400,000 (not 10,000,000)
- Founder Ownership: 51.3% (not 31.6%)
This illustrates why full ratchet is considered extremely aggressive and founder-unfriendly.
When Full Ratchet Appears
Full ratchet protection appears primarily in high-risk investment scenarios, despite modern venture capital moving toward weighted average formulas.
Typical Use Cases:
| Scenario | Rationale | Prevalence |
|---|---|---|
| Bridge rounds | Missed milestones, emergency funding | High |
| Distressed investments | Company survival in question | Very High |
| Pivot financing | Business model completely changing | High |
| Pre-product companies | No market validation | Moderate |
Modern venture capital largely avoids full ratchet in favor of weighted average protection. However, it persists in certain markets (emerging markets, Asia, India) and industries (biotechnology, hardware, deep tech).
Negotiation Strategies
Founders should negotiate limitations on full ratchet provisions when they appear in term sheets:
Common Negotiation Approaches:
- Weighted average substitution - Replace with broad-based or narrow-based formulas
- Time limits - Full ratchet expires after 12-24 months
- Cumulative caps - Maximum adjustment limit (e.g., 2x share increase)
- Carve-outs - Exclude specific issuances (employee options, strategic partnerships)
- Milestone-based conversion - Changes to weighted average upon achieving targets
Employee Option Pool Effects
Employee stock options sit at the bottom of the preference stack, making them most vulnerable to full ratchet dilution. A 15% option pool can drop to 7-8% after full ratchet adjustments, often requiring expensive repricing programs or pool size increases.
Typical Employee Option Impact:
- Pre-down round: 1,500,000 options from 10,000,000 total shares = 15%
- Post-full ratchet: Same 1,500,000 options from 19,000,000 total shares = 7.9%
Options lose nearly half their ownership percentage without any change in option count.
Frequently Asked Questions
How does full ratchet differ from weighted average anti-dilution?
Full ratchet adjusts conversion price based solely on the new share price, while weighted average considers both price and quantity. Full ratchet provides maximum investor protection but causes severe founder dilution, whereas weighted average balances protection with fairness.
When is full ratchet anti-dilution commonly used?
Full ratchet appears primarily in high-risk scenarios including bridge rounds, distressed financing, company pivots, and emerging market investments. It's rare in standard venture capital deals, where broad-based weighted average is the market standard.
How much dilution can founders expect from full ratchet provisions?
In a moderate down round (50% price reduction), founders might see 20-30% ownership reduction. In severe down rounds (80%+ price reduction), founders can lose majority control entirely.
Can full ratchet provisions be negotiated?
Yes. Founders can negotiate time-based sunsets (12-24 months), milestone-based conversions to weighted average, cumulative adjustment caps, or specific carve-outs. Experienced founders often make these limitations deal requirements.
What happens to employee stock options under full ratchet?
Employee options suffer significant dilution as the total share count increases while option quantities remain fixed. A 15% option pool might drop to 7-8% after adjustments, requiring repricing programs or pool size increases to maintain retention.
Key Takeaway
Full ratchet anti-dilution provides the strongest possible investor protection by adjusting conversion prices to the lowest subsequent share issuance price. However, this protection comes at a severe cost to founders and common shareholders, making it heavily negotiated and rare in modern venture capital. Understanding full ratchet mechanics helps founders anticipate down round risks and negotiate appropriate limitations or weighted average alternatives during fundraising.