Full Ratchet

What is a ratchet in private equity?

In venture and growth financings a ratchet is price-based anti-dilution: a contractual reset of a preferred series' conversion price when the company later sells stock more cheaply. A full ratchet resets that conversion price all the way down to the new, lower price per share, regardless of how few shares were sold at it.

Where the term actually lives

It is a charter term, not a side agreement. The NVCA Model Certificate of Incorporation, updated October 2025, carries two alternative versions of Section 4.4.4, each preceded by a bracketed drafting instruction telling the drafter which to use. One reads "Use the following Section 4.4.4 if the terms sheet calls for a broad-based weighted average anti-dilution provision." The other reads "Use the following Section 4.4.4 if the term sheet calls for a full ratchet anti-dilution provision." The charter is downstream of the term sheet; whichever word appeared there is what gets filed in Delaware.

The full ratchet version says that if the company issues Additional Shares of Common Stock without consideration or for a consideration per share less than the Conversion Price of a series in effect immediately before the issuance, then that Conversion Price "shall be reduced, concurrently with such issuance or deemed issuance, to the consideration per share received by the Corporation for such issue or deemed issue of the Additional Shares of Common Stock." If the issuance was for no consideration at all, the charter deems the company to have received an aggregate of $0.001.

Two bracketed options in that same paragraph are the ones worth fighting for. The clause opens "In the event the Corporation at any time after the Original Issue Date [and prior to [Date]]" — that bracket is the sunset, after which the ratchet stops applying. And Section 4.4.2 lets the protection be waived: no adjustment is made if the company receives written notice from the Requisite Holders, or from the holders of a majority of the series, agreeing that none should be made.

How the reset turns into shares

Conversion Price is not the number of shares. Section 4.1.1 says each share of Preferred Stock converts into the number of shares of Common Stock determined by dividing the applicable Original Issue Price by the applicable Conversion Price. The Original Issue Price is fixed at closing. So halving the Conversion Price doubles the conversion ratio, quartering it quadruples it, and the extra shares come out of everyone else's percentage.

Two definitions control how often the trigger fires. Additional Shares of Common Stock means everything issued after the Original Issue Date other than the Exempted Securities, and the charter's exempted list covers the employee plan, shares actually issued on exercise or conversion of previously counted options and convertible securities, shares issued in a firm underwritten public offering, and bracketed carve-outs for equipment lessors and lenders, suppliers and service providers, acquisition consideration and strategic partnerships. Section 4.4.3 then deems options and convertible securities to be issued when granted, at the maximum number of underlying shares, so a cheap option grant or a low-cap convertible can trip a ratchet before any stock is sold.

One drafting detail saves companies real money: the Multiple Closing Dates provision readjusts the Conversion Price to treat all the issuances in a single transaction or series of related transactions, occurring within a bracketed window of no more than 180 days, as if they had happened on the date of the first issuance, without additional adjustments for the later ones. Without that, a tranched down round can ratchet more than once.

Worked example, arithmetic shown

All figures are hypothetical.

Starting point. Series A buys 4,000,000 shares at $1.00 per share, investing $4,000,000. Original Issue Price and initial Conversion Price are both $1.00. Common stock and options outstanding are 6,000,000 shares. Fully diluted is 6,000,000 + 4,000,000 = 10,000,000 shares, so Series A holds 40.0 percent.

The down round. The company sells 5,000,000 new shares at $0.25 per share, raising $1,250,000. The new price is below the $1.00 Conversion Price, so Section 4.4.4 fires.

Full ratchet result.

• New Conversion Price equals the consideration per share received: $0.25.
• Conversion ratio: $1.00 Original Issue Price divided by $0.25 Conversion Price = 4.0 shares per preferred share.
• Series A as converted: 4,000,000 x 4.0 = 16,000,000 shares.
• Fully diluted after the round: 6,000,000 + 16,000,000 + 5,000,000 = 27,000,000 shares.
• Series A: 16,000,000 / 27,000,000 = 59.3 percent. Common and options: 6,000,000 / 27,000,000 = 22.2 percent. New round: 5,000,000 / 27,000,000 = 18.5 percent. Those three add to 100.0 percent.

Broad-based weighted average on the same facts. The formula in the alternative Section 4.4.4 is CP2 = CP1 x (A + B) / (A + C), where A is the fully diluted shares outstanding immediately before the issuance, B is the number of shares that would have been issued if the new money had come in at CP1, and C is the number of Additional Shares actually issued.

• A = 10,000,000.
• B = aggregate consideration divided by CP1 = $1,250,000 / $1.00 = 1,250,000.
• C = 5,000,000.
• CP2 = $1.00 x (10,000,000 + 1,250,000) / (10,000,000 + 5,000,000) = $1.00 x 11,250,000 / 15,000,000 = $0.75.
• Series A as converted: 4,000,000 x ($1.00 / $0.75) = 5,333,333 shares.
• Fully diluted: 6,000,000 + 5,333,333 + 5,000,000 = 16,333,333 shares.
• Series A: 32.7 percent. Common and options: 36.7 percent. New round: 30.6 percent.

Read the two side by side. The same $1,250,000 issuance costs common 14.5 percentage points more under the ratchet (36.7 versus 22.2), and it also costs the incoming investor 12.1 points (30.6 versus 18.5). A ratchet on the cap table is not only a founder problem; it is the reason the next investor may refuse to fund at all until it is removed.

How it shows up in documents

The ratchet sits in Article Fourth of the Certificate of Incorporation, inside the Conversion section, because it changes a stock right and therefore has to be in the charter. Neighbors to read at the same time: Section 4.4.2, the holder waiver; Section 4.4.3, the deemed-issuance machinery for options and convertible securities; Section 4.4.5, which tells you how consideration is computed for non-cash issuances; and, if the term sheet also called for pay-to-play, Section 5A, the Special Mandatory Conversion. The model charter's own preliminary note describes that provision as one under which "Preferred Stock investors are penalized if they fail to invest to a specified extent in certain future rounds of financing," with the penalty being conversion of some or all of the non-participating investor's Preferred Stock into Common Stock.

That pairing is the practical answer to a ratchet demand. An investor who wants full protection against a cheaper round should be willing to fund their share of it.

Common mistakes

• Arguing about the ratchet in the term sheet and then not reading the charter, where the sunset bracket and the waiver threshold actually get set.
• Forgetting that option grants and convertible securities can be deemed issuances under Section 4.4.3 and can trip the reset with no priced round at all.
• Leaving the Multiple Closing Dates window blank, so a tranched recapitalization ratchets twice.
• Assuming the ratchet only affects founders, when it dilutes every earlier series that lacks the same protection and the incoming investor too.
• Confusing a conversion price reset with a change in the liquidation preference; the preference is unchanged, only the as-converted share count moves.

How it relates to adjacent terms

Full ratchet is one end of the anti-dilution range whose other end is broad-based weighted average, and narrow-based weighted average sits between them by shrinking A in the formula so the same issuance produces a lower CP2. Its trigger is the down round, and its natural counterweight is pay-to-play, which conditions continued protection on writing another check.

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