VC & PE Glossary
What Is Ratchet?
Updated
Definition
In venture and PE, a ratchet is a contract mechanism that adjusts investor ownership or conversion price if future financing or performance triggers occur — protecting investors from dilution or valuation drops at founders' expense. Full ratchets are rare today; weighted-average anti-dilution is standard.
Useful for: Founders, Investors
A ratchet adjusts investor economics when specified triggers hit — most famously anti-dilution protection when a company raises at a lower price than a prior round.
How it works
A full ratchet reprices earlier preferred as if it had invested at the new lower price — maximally punitive to common. Weighted-average ratchets (broad-based or narrow) blend old and new prices by shares outstanding — standard in NVCA docs. Other ratchets tie to revenue or IPO valuation milestones, granting extra shares if targets miss. PE earnouts sometimes ratchet purchase price based on post-close performance.
In distressed venture rounds, structured ratchets or pay-to-play packages appear alongside recapitalizations. Modeling tools show how each scenario shifts founder ownership.
Why it matters
- Founders: Negotiate broad-based weighted average; avoid full ratchet unless no alternatives exist.
- Investors: Ratchets protect prior money in down scenarios but can destroy alignment if too harsh.
- Employees: Option pools dilute further when ratchets fire — refresh grants may lag reality.
Common mistake
Ignoring anti-dilution until a down round. Founders discover prior Series A language converts paper wealth to near-zero common overnight.
Related ideas
Anti-dilution, /glossary/down-round, pay-to-play, and recapitalization.
Related terms
- Anti-Dilution — Anti-dilution protection adjusts an investor's conversion price if the company issues shares later at a lower price—protecting early preferred holders from down-round dilution beyond normal ownership math.
- Down Round — A down round is a financing where a company raises capital at a lower valuation per share than its previous round—diluting existing shareholders and often triggering protective provisions.
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Common questions
Short answers for founders, LPs, and operators