Full Ratchet: An Alternative to Protect Early Investors

When it comes to venture capital and angel investments, the full ratchet provision is one of the most popular anti-dilution protections available. It can be extremely beneficial for early investors, as it ensures that their ownership is not diluted in the event of future rounds of fundraising. In the simplest terms, the full ratchet means that the adjusted option price (or conversion ratio) for existing shareholders will always be equal to the lowest sale price from later rounds of fundraising.

At its core, the full ratchet provision creates a protective shield for early investors. By applying the lowest sale price, it allows them to maintain their ownership stake regardless of what other investors come into the company. This can be extremely valuable for early investors, as it ensures that they are not penalized for later rounds of fundraising.

Unfortunately, the full ratchet is not without its drawbacks. First and foremost, it can be extremely costly for founders, as it can limit their ability to raise capital in the future. Additionally, the full ratchet means that early investors don’t share the same risks or upside as later investors. This can be particularly problematic if the company experiences a surge of growth in later rounds.

As a result of these drawbacks, the full ratchet has largely been replaced by the weighted average approach. This approach involves weighted conversions that take into account the contribution of each investor as well as the price of each round of fundraising. This ensures that all investors share the same risks and rewards, while still allowing early investors to maintain some degree of protection from dilution.

In conclusion, the full ratchet is an anti-dilution provision that’s used to protect early investors. It applies the lowest sale price as the adjusted option price or conversion ratio for existing shareholders, ensuring that their ownership is not diluted in the event of future rounds of fundraising. However, the full ratchet has drawbacks that can be costly for founders and limit their ability to raise capital in the future. As such, the weighted average approach has largely replaced the full ratchet as the preferred method of protection for early investors.