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Full Ratchet: A Comprehensive Guide to Investor Protection
Definition & Meaning
A full ratchet is a provision designed to protect investors from dilution of their ownership in a company. This mechanism ensures that if a company issues new shares at a lower price than what the investor originally paid, the conversion price of the investor's options or convertible securities adjusts to match that lower price. As a result, the investor maintains the same percentage of ownership in the company as when they made their initial investment.
Table of content
Legal Use & context
Full ratchet provisions are commonly used in venture capital and private equity transactions. They are particularly relevant in negotiations involving convertible securities, where investors seek to protect their investments from future dilution. This term is significant in corporate law, especially in the context of financing rounds, mergers, and acquisitions. Users can manage related legal documents using templates from US Legal Forms, which are drafted by experienced attorneys.
Key legal elements
Real-world examples
Here are a couple of examples of abatement:
(Hypothetical example) An investor initially purchases convertible notes at a price of $10 per share. If the company later issues shares at $5 per share, the full ratchet provision allows the investor to convert their notes into shares at the new lower price of $5, thus maintaining their ownership percentage.
Comparison with related terms
Term
Definition
Difference
Full Ratchet
A provision that adjusts the conversion price of securities to the lowest price at which new shares are issued.
Protects against dilution by adjusting prices based on new share issues.
Weighted Average Ratchet
A provision that adjusts the conversion price based on a weighted average of the prices at which new shares are issued.
Less protective than a full ratchet, as it considers all share prices rather than just the lowest.
Common misunderstandings
What to do if this term applies to you
If you are an investor concerned about dilution, review your investment agreements for full ratchet provisions. If such protections are not included, consider negotiating their inclusion in future agreements. For assistance, explore US Legal Forms' templates for investment contracts or seek professional legal guidance if your situation is complex.
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Typical use: Venture capital and private equity financing.
Purpose: Protects investors from dilution.
Common in: Convertible securities and options agreements.
Key takeaways
Frequently asked questions
A full ratchet is a provision that adjusts the conversion price of securities to the lowest price at which new shares are issued, protecting investors from dilution.
It ensures that if new shares are issued at a lower price, the conversion price for existing securities is adjusted to match that lower price.
No, it must be negotiated and included in the investment agreement or term sheet.