Bad times may well cause this beast to come out of its cave. Full ratchet antidilution is a provision that protects investors to the max from low priced issuances. The gist of this provision is that the conversion price of a security (usually preferred stock, but not necessarily) will be reduced to the lowest price at which a company sells any shares of its common stock. So, if you have 1,000,000 shares of preferred outstanding with a conversion rate of $1.00, these shares will convert into 1,000,000 shares of common stock. However, if these shares have a full ratchet antidiluton provision and you issue one share of common stock for $.10, then the conversion rate will drop to $.10, and the preferred stock will convert into 10,000,000 shares. You can imagine the dilutive effect on other stockholders. 

For the reason outlined above, full ratchet is rarely used. However, it does have its place when there is a disagreement about valuation. If you can’t bridge the valuation gap, you might end up saying something like “OK, if I have to raise money next year at a lower valuation than you are getting, I will adjust you to that valuation.” In a world where money is very hard to come by and investors are very nervous about valuation, I predict we will start seeing more of these provisions.

Having said that, if you are constrained to agree to full ratchet, you need to consider negotiating some parameters around it. By way of example, try to exclude options issued under the option plan, try to exclude small issuances of warrants to equipment lessors, try to limit the time period in which the full ratchet operates to some period (perhaps one year). Consider other issuances that you might make and try to negotiate exceptions for them. Also, consider a range inside of which you don’t have to make the adjustment. For example, consider trying to negotiate a provision the gist of which is that the full ratchet will only operate if you raise more than $X at a valuation that is less than 90% of the preferred.

Full ratchets have another negative effect, they cause the next investor to want one too. Consider negotiating a termination upon closing of the next round.

I predict that the next year will see an increase in full ratchet provisions.