Full ratchet anti-dilution is defined as a price protection mechanism that adjusts an investor’s preferred stock conversion price downward to match the per-share price of any subsequent financing round issued at a lower valuation. It is the most aggressive form of anti-dilution protection available to investors.
How Full Ratchet Works
When a company raises a new round at a lower price per share than a previous round, full ratchet protection resets the earlier investor’s conversion price to the new, lower price. The critical feature: the adjustment ignores the size of the down round entirely.
Here is a concrete example. An investor purchases Series A preferred at $10 per share. Later, the company raises a Series B at $4 per share. Under full ratchet, the Series A conversion price drops from $10 to $4. The investor’s shares now convert into 2.5x as many common shares as originally issued, as if they had invested at $4 from the start.
Compare this to a weighted average adjustment, which would factor in how many new shares were issued at $4. If the Series B is a small round, the weighted average adjustment might lower the conversion price to $8 or $9 rather than all the way down to $4.
The Impact on Founders and Employees
Full ratchet creates an asymmetric outcome. The protected investor’s ownership percentage increases substantially, and that increase comes directly from the common shareholders, which means founders, employees, and anyone holding options.
In severe down rounds, full ratchet can push founder ownership below meaningful thresholds, sometimes to the point where management has little economic incentive to continue building the company. This is why many venture lawyers advise founders to resist full ratchet and insist on weighted average protection instead.
Smart investors understand this dynamic too. A full ratchet that destroys founder motivation is a pyrrhic victory. The shares may convert into a larger percentage of a company that no one is motivated to grow.
When Full Ratchet Appears
Full ratchet is most commonly seen in:
- Bridge financings where existing investors provide emergency capital and demand maximum downside protection
- Late-stage or crossover rounds where institutional investors with significant leverage negotiate aggressive terms
- Distressed situations where the company has limited alternatives and must accept investor-friendly terms
In standard Series A or Series B financings led by institutional venture firms, full ratchet is uncommon. The National Venture Capital Association (NVCA) model term sheet uses broad-based weighted average as the default, and most experienced investors follow this convention.
Carve-Outs and Modifications
Even when full ratchet is agreed to, the provision typically includes carve-outs for shares issued under the employee option pool, shares issued in acquisitions, and shares issued upon conversion of existing instruments like convertible notes. Without these exceptions, routine equity issuances would trigger the ratchet and create unworkable cap table complications.
Some agreements include a time-based sunset, converting the full ratchet to weighted average after 12 or 18 months if no down round has occurred. This compromise gives the investor short-term protection while limiting the long-term severity of the provision.
Frequently Asked Questions
What is the difference between full ratchet and weighted average anti-dilution?
Full ratchet resets the conversion price to the exact price of the new lower round, regardless of how many shares are issued. Weighted average factors in the size of the new round relative to the existing shares, producing a less severe adjustment. Weighted average is far more common in practice.
How does full ratchet affect founders in a down round?
Severely. Full ratchet effectively reprices all of the protected investor's shares to the new lower price, dramatically increasing their ownership percentage. This dilutes founders and employees far more than a weighted average adjustment would. In a significant down round, it can shift majority control to investors.
Is full ratchet common in venture capital?
No. Full ratchet is relatively rare in standard venture financings. Most deals use broad-based weighted average anti-dilution instead. Full ratchet is more common in distressed situations, bridge rounds, or deals where the investor has significant leverage.
