Full-Ratchet Anti-Dilution

Full-ratchet anti-dilution protection is the strictest form of protection against dilution. If the company later issues shares at a lower price, the entry price of the protected investor is fully adjusted to this new level. This strongly benefits the investor and burdens the other shareholders.

Crucially, the size of the new round plays no part: even where only a very small amount is raised at a low price, the adjustment is made in full, as if the entire earlier investment had been made at that price. That is exactly the difference from a weighted average, which takes the size of the new round into account and therefore provides a far milder adjustment. The economic effect can be substantial: the protected investor receives additional shares whose number, after a steep fall in valuation, can be a multiple of the original holding, while the percentages of founders, employees and unprotected shareholders fall accordingly. This variant is not market standard in German venture capital. It appears mainly in distressed situations, in bridge financings and where an investor has a very strong negotiating position.

Counter-measures are a time limit on the protection, restriction to specific rounds, exceptions for employee plans and convertible instruments, and a pay-to-play provision under which protection is available only to investors participating pro rata in the new round. For founders the most effective protection is avoiding the triggering situation, meaning a valuation that can be confirmed in the next round. An inflated valuation today buys short-term dilution advantages at a considerable risk in the following round. A model calculation before signing is equally advisable, showing how ownership would change if valuation fell by various percentages, because the clause's effect is hard to judge in the abstract.