Guide

Priced rounds and term sheets

Full ratchet

The harsh anti-dilution formula that resets the old conversion price all the way to the new cheap price, even on a tiny round.

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Full ratchet is the simplest anti-dilution formula and the harshest. When the company later sells shares cheaper than a preferred investor paid, that investor's conversion price drops all the way to the new price — no matter how small the cheap round is.

Concept

Preferred stock usually converts into common at a conversion price (at first, the price paid per preferred share). Anti-dilution lowers that conversion price, so each preferred share turns into more common. Ownership shifts from common toward the protected preferred.

The big idea

Imagine you bought a house at $400k. A neighbor later sells an identical house for $100k, and the city rewrites your deed as if you had also paid $100k — so you now own four houses for the original check. That is a ratchet. The analogy breaks because the neighbor may have sold only a shed. Full ratchet does not care about size.

CP2 = New Issuance Price

That is the whole formula. Weighted average is the market alternative: it blends old and new prices by how much money came in.

Walking through it

Series A paid $4.00 for 1,000,000 preferred shares ($4M invested). Conversion was 1:1 into common. Series B sells only 100,000 shares at $1.00 — a tiny $100k close.

CP2 = $1.00
Each Series A share converts into 4.00 / 1.00 = 4 common
Series A as-converted shares = 4,000,000

Founders are crushed even though almost no capital arrived at the low price. That asymmetry is why full ratchet is considered aggressive and non-market on a healthy term sheet. Resist it. If a distressed deal demands it, you are in restructuring territory.

On a large down round the same rule still doubles that Series A block (price $2.00 → $1.00), which can try to restore the old percentage while new money also buys a pile of shares. Common and employees absorb the hit. New money in a ratchet company often then demands a recap.

Common mistakes

  • Signing it because the rest of the sheet looked friendly. This one clause can move more ownership than valuation did.
  • Thinking a tiny down round is "small damage." Ratchet ignores size. $100k at a fire-sale price can rewrite the table.
  • Reading "Series A still has two million shares" as comfort. Ask "at what conversion price?" The extra common hides there.

Check yourself

Series A bought at $4.00. A $100k round prices at $1.00. What is the new conversion price under full ratchet?

$1.00 — the new issuance price, regardless of how small the round is.

Why do founders fight this on an otherwise ordinary Series A?

A later tiny down round can multiply the investor's as-converted shares and devastate common.

Key takeaways

  • Full ratchet sets the old conversion price equal to the new cheap price.
  • Round size does not matter, which is why a small fire sale can crush founders.
  • It is non-market on healthy sheets; treat it as a distress term.

Further learning

Next, the market formula: broad-based weighted average.

Anti-dilution protection

Extra conversion-price math for old preferred when a later round is cheaper — not ordinary new-money dilution.

Weighted-average anti-dilution

The market formula CP2 = CP1 × (A+B)/(A+C), plus why the definition of A (narrow vs broad) changes the pain.

Down rounds

A priced round cheaper than the last one — what happens to founders, employees and anti-dilution.