A full ratchet is a type of anti-dilution provision that aids investors in maintaining his or her percentage of ownership in a given company. This type of provision is typically associated with convertible securities in which there is the opportunity to convert preferred shares into common shares of stock. The full ratchet functions by providing the investor with the right to convert the shares and receive more shares at the adjusted price. Doing so serves as a means of balancing out any shifts in price that threaten to decrease the investor’s stake in the company.
An example of a full ratchet would be an investor who purchases convertibles at a price of $5.00 US dollars (USD). If more convertibles are subsequently sold in a later round of financing for $2.50 USD, the investor will have the opportunity to exercise the conversion at the most current price. This would make it possible to double the number of shares owned by the investor, effectively maintaining his or her stake in the business. Assuming those shares subsequently increase in value, the investor stands to earn a significant amount of return from the increased number of shares, even though the percentage of the number of issued shares has remained the same.
Maintaining the percentage of interest or the stake in a business can be extremely important for investors. This is particularly true when the provisions associated with the acquired shares allow the investor to cast a vote in various matters pertaining to the ongoing operation of the company. Even when voting privileges are not involved, the option of maintaining the current stake can be important to the investor, especially if the new company is expected to gain momentum over the short term and eventually become an industry leader. By continuing to maintain that same stake, the returns will increase as the company grows in prominence and increases its sales volume.
The main benefit of a full ratchet is that the provision serves to minimize the opportunity for investors to incur losses due to the generation of another round of financing. At the same time, this type of provision can create hardship for the issuing company under certain circumstances. For this reason, the full ratchet is not necessarily associated with all stock options, especially in nations where this type of investor protection is not required by law to be included in the terms and conditions associated with the issuance of the stock.
