Deal Terms
Ratchet
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Quick Answer
An aggressive anti-dilution mechanism that resets an investor's conversion price to the lower of the original price or any subsequent lower price — also called full ratchet.
What it is
A ratchet (or full ratchet anti-dilution) is the most aggressive form of anti-dilution protection. If a company issues a single share at a lower price than the investor paid, the ratchet resets the investor's entire conversion price to that lower price — regardless of how many shares were issued at the lower price. This is extremely punitive for founders: if one share is sold in a down round at a 90% discount, all of the investor's preferred converts at 10% of the original price. Full ratchets were common in the dot-com era and resurface in severe down rounds where investors have maximum leverage. They're considered a highly unfavorable, founder-hostile term. Weighted average anti-dilution is the fair market alternative.
In Practice
Venture Capital Partners invests $5M in TechCorp at $2.00 per share ($20M pre-money valuation). The investment includes full ratchet anti-dilution protection. Six months later, TechCorp struggles and raises a down round at $0.50 per share. Under the full ratchet provision, Venture Capital Partners' conversion price automatically resets from $2.00 to $0.50 per share. This means their original $5M investment now converts to 10 million shares instead of 2.5 million shares, dramatically increasing their ownership percentage at the expense of founders and employees who don't have ratchet protection.
Operational context
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Why It Matters
Full ratchets can devastate founder and employee equity stakes in down rounds, sometimes reducing their ownership to single digits. For investors, while ratchets provide downside protection, they can demotivate management teams and make future fundraising extremely difficult. Companies with ratchet provisions often struggle to attract new investors who don't want to trigger the harsh reset mechanism. Understanding ratchets is crucial for founders to avoid signing terms that could eliminate their upside in challenging scenarios.
VC Beast Take
Full ratchets are the nuclear option of anti-dilution protection — they're designed to punish rather than protect. Most sophisticated VCs avoid them because they recognize that completely destroying management incentives usually destroys company value too. We typically see ratchets from inexperienced investors or in hostile situations. Weighted average anti-dilution is almost always the better choice for everyone involved, maintaining alignment while still providing reasonable downside protection.
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Further Reading
VC Term Sheet Template & Guide: Every Clause Explained with Examples
A clause-by-clause breakdown of every standard VC term sheet provision — what each term means, what's market, what to negotiate, and the red flags that cost founders millions.
NVCA Model Legal Documents: Every Form a Startup Founder Needs
The NVCA publishes free legal templates that can save you $10-30K in lawyer fees. Here's every document explained in plain English, plus what to watch for.
VC Interview Questions: 30 Questions They'll Actually Ask (With Answers)
30 real VC interview questions organized by category: technical, market thesis, deal evaluation, and behavioral. With frameworks for answering each one.
The Real Cost of Raising Venture Capital (Fees, Dilution, and Hidden Risks)
Most founders think raising $5M means getting $5M. It doesn't. Here's the real math on dilution, legal fees, time costs, and hidden terms that nobody warns you about.
Series B, C, D, and E Funding: What Each Round Means for Your Startup
Series B, C, D, and E rounds each signal a different stage of risk reduction and scaling. Here's what investors expect at each stage, what valuations look like, and how dilution compounds.
What Is a Term Sheet? Definition, Format, and Sample Template
A term sheet is the foundational document in any VC deal. Learn the definition, format, key sections, and see a sample template to help you negotiate with confidence.
Related Questions
What is a down round?
A down round is a funding round where a company raises capital at a lower valuation than its previous round. It dilutes existing shareholders and triggers anti-dilution provisions for preferred investors.
What is a term sheet in venture capital?
A term sheet is a non-binding document outlining the key terms and conditions of a proposed investment, serving as the basis for negotiating a final deal.
What is a term sheet?
A term sheet is a non-binding document that outlines the key terms of a proposed investment — valuation, amount, ownership percentage, and governance rights. It's the starting point for negotiating a deal.
What is anti-dilution protection in venture capital?
Anti-dilution protection adjusts an investor's share price downward if the company later raises money at a lower valuation, protecting the investor from being diluted by a down round.
Frequently Asked Questions
What is Ratchet in venture capital?
A ratchet (or full ratchet anti-dilution) is the most aggressive form of anti-dilution protection. If a company issues a single share at a lower price than the investor paid, the ratchet resets the investor's entire conversion price to that lower price — regardless of how many shares were issued at...
Why is Ratchet important for startups?
Understanding Ratchet is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
What category does Ratchet fall under in VC?
Ratchet falls under the deal-terms category in venture capital. This area covers concepts related to the financial and legal terms that define investment agreements.
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