# Full Ratchet Anti-Dilution: Definition, Example, and Alternative

> **Definition**
>
> A full ratchet is an anti-dilution provision that adjusts the option price or conversion ratio for shareholders to the lowest sale price. This prevents ownership dilution for early investors in subsequent fundraising rounds, but can make it harder to attract new rounds of investment. A weighted average approach is a fairer alternative for balancing the interests of founders, early investors, and later investors.

## What Is a Full Ratchet?

A full ratchet is a contractual provision designed to protect the interests of early investors. Specifically, it is an [anti-dilution provision](https://www.investopedia.com/terms/a/anti-dilutionprovision.asp) that applies, for any shares of common stock sold by a company after the issuing of an option (or convertible security), the lowest sale price as the adjusted option price or [conversion ratio](https://www.investopedia.com/terms/c/conversionratio.asp) for existing shareholders.

### Key Takeaways

  

*   Full ratchet anti-dilution applies the lowest sale price for options or conversion ratios, protecting early investors.  
    
*   This provision can be costly and may deter future investment rounds due to ownership dilution concerns.  
    
*   Full ratchet provisions often have a limited duration to balance founder and investor interests.  
    
*   Weighted average anti-dilution provisions are a popular alternative, offering a fairer balance for all parties.

## How Full Ratchets Protect Early Investors

A full ratchet protects early-stage investors by ensuring that their percentage ownership is not diminished by future [rounds of fundraising](https://www.investopedia.com/articles/personal-finance/102015/series-b-c-funding-what-it-all-means-and-how-it-works.asp). This provision also offers a level of cost protection should the pricing of future rounds be lower than that of the initial round.

There are some caveats, though. Offering these assurances to early-stage investors can be quite expensive from the perspective of company founders or investors participating in later rounds of fundraising.

A full ratchet provision can make it hard for the company to attract new investments. For this reason, full ratchet provisions are usually only kept in force for a limited period of time.

## Example: Full Ratchet Impact on Shareholders

To illustrate, consider a scenario in which a company sells 1 million convertible [preferred shares](https://www.investopedia.com/terms/p/preference-shares.asp) at a price of $1.00 per share, under terms that include a full ratchet provision. Suppose that the company then undertakes a second fundraising round, this time selling 1 million [common shares](https://www.investopedia.com/terms/c/commonstock.asp) at a price of $0.50 per share.

Because of the full ratchet provision, the company must lower the conversion price of preferred shares to $0.50 to compensate shareholders. Effectively, this means that the preferred shareholders would need to be given new shares (at no additional cost) in order to ensure that their overall ownership is not diminished by the sale of the new common shares.

This can lead to issuing new shares to satisfy both original preferred shareholders, benefiting from the full ratchet, and new investors seeking a fixed company percentage. After all, investors desire not just an abstract number of shares, but a concrete percentage of ownership.

In this scenario, founders may see their ownership stakes reduced by adjustments favoring both old and new investors.

## Comparing Full Ratchet and Weighted Average Anti-Dilution Strategies

A weighted average approach is a fairer alternative for balancing founder, early investor, and later investor interests. This approach comes in two varieties: the [narrow-based weighted average](https://www.investopedia.com/terms/n/narrowbasedweightedaverage.asp), and the [broad-based weighted average](https://www.investopedia.com/terms/b/broadbasedweightedaverage.asp).