Full ratchet is an anti-dilution provision that resets an earlier investor’s conversion price to the lower price in a down round. For founders, the key question is how that reset changes ownership and who absorbs the resulting dilution.
What does full ratchet mean in a term sheet?
A conversion price determines how an earlier investment converts into shares. If a company later raises money at a lower price, a full ratchet provision changes the earlier investor’s conversion price to that new, lower price.
The adjustment is not based on the number of shares sold in the later financing. If the provision is written this way, even a small issuance at the lower price can trigger a reset to that price.
That makes full ratchet a particularly strong form of anti-dilution protection for the investor receiving it. Because the adjusted price is lower, the investment may convert into more shares than it would have at its original conversion price. The additional dilution affects the company’s capitalization, with founders and employees among those who may bear the cost.
The term describes a specific adjustment mechanism, not the full effect of a financing. To understand the consequences, you need to read the actual clause and consider how the company’s ownership changes if a future financing is priced below an earlier one.
How does full ratchet work in a down round?
A down round is a financing at a lower price than an earlier financing. Under a full ratchet provision, the earlier investor’s conversion price resets to the new lower price. The defining feature is that the reset does not shrink in proportion to the number of shares issued in the down round.
The sequence is straightforward:
- An earlier investment has a conversion price.
- The company later raises at a lower price.
- The full ratchet provision resets the earlier conversion price to that lower price.
- At conversion, the adjusted price can result in more shares for the earlier investor.
No deal-specific prices or share counts are provided here, so a numerical example would depend on assumptions. You can still assess the core effect: the new financing price sets the adjusted conversion price, while the number of shares sold in that financing does not determine how much the price resets.
This distinction matters when you review the financing as a whole. The later round may involve a small issuance, but that does not necessarily limit the adjustment for the investor protected by the clause.
How is full ratchet different from weighted-average protection?
Broad-based weighted-average anti-dilution is a common alternative to a full ratchet. Both approaches address a later financing at a lower price, but they calculate the conversion-price adjustment differently.
| Provision | How the conversion price changes |
|---|---|
| Full ratchet | Resets to the new lower financing price, without scaling the adjustment to the number of shares issued |
| Broad-based weighted average | Adjusts in proportion to the size of the down round |
The practical difference is that a weighted-average adjustment takes the size of the down round into account. A full ratchet does not make the reset proportional to the amount of shares sold. That can make full ratchet more burdensome for other holders, including founders and employees.
When comparing the terms, focus on the actual calculation and its effect on conversion. The label alone does not tell you how the clause will operate in your financing. Ask what event triggers it, which conversion price changes, and how the adjustment affects ownership.
What should founders negotiate in a full ratchet clause?
Treat the provision as part of the complete financing, not as an isolated piece of standard language. Review the precise trigger and calculation, then ask who could be affected if the company later raises at a lower price.
Useful questions to work through include:
- Which financing events trigger the adjustment?
- How does the clause change the earlier investor’s conversion price?
- Does the provision reset the price fully, or adjust it in proportion to the down round?
- How could the adjustment change the ownership consequences for founders and employees?
- How does the proposed clause compare with broad-based weighted-average anti-dilution?
Full ratchet can concentrate more of the down-round dilution on founders and employees. That distributional impact is a reason to examine the language carefully before agreeing to it. The term may protect one investor while making the ownership outcome less favorable for others who continue building the company.
For founders, treat full ratchet as a red flag and negotiate hard against it, particularly at an early stage. The general guidance is to almost never accept it that early, and most credible investors do not ask for it. These points are not a substitute for reviewing the specific agreement with qualified legal counsel.
What mistakes should founders avoid?
Some misunderstandings can make it harder to evaluate the clause’s consequences:
- Assuming it is harmless boilerplate. A conversion-price reset can affect who bears dilution in a future down round.
- Looking only at the financing happening now. The clause concerns what may happen if a later financing has a lower price.
- Confusing a full reset with a proportional adjustment. Full ratchet resets to the new lower price; broad-based weighted average adjusts in proportion to the size of the down round.
- Discussing the label without the outcome. Focus on the trigger, calculation, conversion effect, and distribution of dilution.
- Rushing through the review. Assess the provision in the context of the full term sheet, ask clear questions, and get qualified legal advice on the actual wording.
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Frequently Asked Questions
Does a full ratchet depend on how many shares the company issues?
No. Its defining feature is that the earlier conversion price resets to the new lower price without scaling the adjustment to the number of shares issued in the down round.
How can a full ratchet affect founders and employees?
The adjustment may give the earlier investor more shares when the investment converts. The resulting dilution can fall on other holders, including founders and employees.
Is broad-based weighted-average anti-dilution the same as full ratchet?
No. Full ratchet resets the conversion price to the new lower price. Broad-based weighted average adjusts the price in proportion to the size of the down round.
Should founders agree to a full ratchet clause?
Almost never accept full-ratchet terms at an early stage, and negotiate hard against them. Review the clause carefully and seek qualified legal advice.
What should you check before signing?
Identify the trigger, understand how the conversion price is recalculated, and consider who bears the dilution in a future down round. Compare the mechanism with broad-based weighted average and review the actual wording with qualified legal counsel.