Ratchet (Full) Dilution
The term ‘full ratchet’ refers to the contractual provision that prevents the dilution of an early investor by future rounds of fundraising. It typically also provides protection against a drop in the strike price, should the pricing of future rounds be lower than that of the initial round. Full ratchet provisions can be extremely dangerous for early stage companies, as they force the company to continue to raise at higher rounds, while simultaneously not allowing the investor to be diluted.Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council. The last thing you want to have happen is you are raising a round of capital and the investor demands that they not be diluted or you have a down round and they expect their original shares to convert at the new (and lower) price.