Ratchet Agreement

Note: it is the founders and ESOP who suffer from dilution, but it is not a perfect protection for the investor. Despite a complete ratchet, the depreciation of the company still means that they have lost about 15%. For weighted average calculations, they fell by 45% against 48% without protection. These protective devices reduce the shock, but do not avoid it completely. A ratchet is a term in which if another VC later pays a lower price for shares in your start-up… VCs, which once bought shares with ratchet protection, receive a price adjustment at this lower price. Consider a scenario in which a company sells 1 million convertible preferred shares at a price of $1.00 per share, under conditions that include a full provision of rattling. Suppose the company then proceeds to a second round of fundraising and this time sells 1 million common shares at a price of $0.50 per share. ABC plans to issue another round of financing (round 3) of $0.5 per share, with the plan to raise $1,000,000. This means that they will issue an additional 2,000,000 shares. In the absence of the total dilution clause, Investor X would significantly weaken its stake in the company, since the total amount of the company`s common shares has increased from one million shares to three million shares.

What happens if the company goes the other way and goes down the road? Suppose an emergency increase of $2 million for a pre-money valuation of $13 million. If the original investor were to take his proportionate stake, he could maintain his 20%, but it would be worth only $3 million compared to the total investment of $5.4 million. The pro-rata right protects your investor from dilution on his part, but offers nothing against the dilution of his value. For this reason, your spreadsheet may contain an anti-dilution or a “click.” On the complete anti-dilution ratchet that we considered, the founding team was at 54% after two rounds. Assuming it would take a few more rounds to get to an exit, and depending on the number of people on the founding team, this could already go beyond the point where an investor would consider the team as a long-term incentive. In a buyback context, they are generally used to reward management, whose share of total share holding may vary depending on the investor`s forecast and forecast and target return.