This means that they will be issuing 2,000,000 additional shares of stock. Preferred stock Round 2 ($2/share): 1,000,000ĪBC projects to issue another round of financing (round 3) at $0.5 per share, with a plan to raise $1,000,000. The current financial structure is as follows: Practical ExampleĬompany ABC is planning to start another round of financing to support its expansion plans. They are not incentivized to purchase additional shares. As long as the investors are satisfied with the percentage amount of their original equity investment, then they can rest assured that their equity position will not be diluted. One possible negative effect of anti-dilution provisions is that they may make it less likely that original investors will contribute in later funding rounds.
#FULL RATCHET URBAN DICTIONARY FULL#
On the other hand, the new shareholders feel the full effects of the dilution since the value of their shareholding becomes lower than that of the current shareholders. The current shareholders benefit from the non-dilution provision since they are protected from any losses associated with the new rounds of financing. The conversion price is adjusted to reflect the conversion price of the shares issued in subsequent rounds. This is achieved by reducing the conversion price to allow investors to convert their preferred stocks into a given percentage of the common stock. The shareholders maintain their stake without incurring additional costs. It prevents the original shareholders’ stake from being diluted by the issue of new shares for new shareholders to subscribe. The goal of the full ratchet is to ensure current investors maintain the same ownership percentage should a company create new rounds of financing. If Investor X wishes to maintain their original percentage of ownership, then having a full ratchet provision attached to their original equity investment in Company ABC. The new stock issue dilutes Investor X’s stake in the company – 100,000 shares – from 10% to 6.67%. This brings the total Company ABC shares to 1,500,000 and the total valuation to $15,000,000. In a new issue of shares, the company offers 500,000 new shares to the public. Investor X’s stake in the company is valued at $1,000,000, which translates to an ownership stake of 10% in Company ABC. With a current market price per share of $10, the company is valued at $10,000,000. ExampleĪssume that Company ABC has 1,000,000 outstanding shares, out of which 100,000 shares are owned by Investor X. The main types of anti-dilution provision are full ratchet and weighted average. It adjusts the conversion price of the preferred stock to common stock and reflects the new round price. The main aim of the provision is to protect existing shareholders from a dilution of the investor’s equity investment. Such dilutions are common with companies that have capitalization tables that include a large number of options and convertible securities. This anti-dilution provision protects investors from dilution caused by new stock issues at a price that is lower than the investor’s original investment. The investor retains their original percentage of ownership – what changes is the number of shares they hold. The provision guarantees that if an equity investment sold in a subsequent funding round decreases the original investor’s equity ownership percentage, then they will be compensated by receiving additional shares sufficient to maintain their percentage of ownership at its original level.Īfter the adjustment, fresh shares should be issued to the investor, without requiring him or her to make any additional payments. Full ratchet is a provision that protects an option holder, or convertible holder, from any dilution of their investment in subsequent rounds of funding.