Full Ratchet Anti-Dilution: How a Ratchet Clause Works in France

You sign a term sheet, then the worry sets in: what if the next round is at a lower valuation? This question remains one of the major friction points in fundraising, because it touches on trust, dilution and control.

In negotiations, the ratchet clause is designed precisely to deal with this downside scenario. It gives certain investors an adjustment mechanism if a later financing is completed at a lower price per share. Used well, it consolidates investors’ commitment and stabilises the valuation discussion. If poorly calibrated, it creates abrupt dilution, lasting tension on the cap table, and sometimes a deadlock in the next round.

This text explains how it works, its variants, its triggers, its risk areas, and the drafting practices that reduce litigation. It deliberately stays at a general and contractual level, because every capital structure and every round calls for its own trade-offs. If you are preparing a shareholders’ agreement, the support of a fundraising lawyer often avoids “trap” clauses that turn against the company just when it needs to accelerate.

Ratchet clause: what are we really talking about?

A ratchet clause provides compensation for an investor if the company later carries out a transaction at a price per share lower than the price that investor paid. The typical case is a down round: a fundraising at a lower valuation than the previous round.

In practice, the clause seeks to preserve the economics of the initial investment. It does not “reimburse” the investor. Instead, it changes the number of securities the investor will hold after the transaction, increasing its shareholding, so that its average cost price per share moves closer to the new price. The mechanism takes the form of an allotment of, or subscription for, additional securities, depending on what the shareholders’ agreement and the issue documentation provide.

This logic sits within a shareholders’ agreement, sometimes supplemented by ancillary undertakings. It also interacts with governance rules, preferential rights and capital transactions, because compensation does not happen “in a vacuum”: it takes place through an issue, a transfer, or a combination of techniques.

Why do investors ask for a ratchet?

An investor accepts a degree of uncertainty, but wants to control certain risks. A fall in valuation is one of the most sensitive risks, because it reduces the theoretical value of existing securities and makes it harder for the company to raise funds.

The ratchet clause then acts as an economic safeguard. It signals that, if the company has to finance a difficult phase at a lower price, the initial investor will not bear the effect of that fall alone. This protection can make the investment decision easier and speed up completion of the round, particularly when the company needs to lock in an amount quickly.

In return, the founder accepts potentially greater dilution than would result from the future round alone. It is a trade-off: a little more protection to obtain the financing, but discipline in managing the cap table to avoid a spiral in the next round.

The two main families of ratchet: full ratchet and weighted average

Full ratchet anti-dilution: the most aggressive adjustment

A full ratchet essentially treats the initial investor as if it should have paid the same price as in the later, lower round. It therefore adjusts its reference price to the new price, without nuance. The lower the new round, the heavier the compensation becomes.

This mechanism often produces very high dilution for the founders and for unprotected shareholders. It can also deter new investors, because it “overloads” the future round: part of the transaction serves to compensate for the past rather than to finance growth.

In practice, many teams accept it only in particular cases: a rescue round, a highly constrained negotiation, or investors demanding maximum protection in return for a risk perceived as exceptional.

Weighted average: the proportionate adjustment

A weighted average aims for a more proportionate adjustment. It takes into account the initial price, the new price, and a volume figure linked to the number of securities concerned. The idea remains the same: reduce the economic impact of a down round on the initial investor, but without tipping into punitive dilution.

In practice, a distinction is drawn between “narrow” and “broad” approaches, depending on whether a narrower or wider base of securities is used for the calculation. The wider the base, the more moderate the adjustment. This family of clauses fits more easily into successive rounds, because it limits the cascade effect on the capitalisation table.

It does not eliminate dilution, but it makes it more predictable, which reduces conflict between shareholders when market conditions deteriorate.

What triggers a ratchet: the clause must never remain vague

A ratchet clause only works if the shareholders’ agreement precisely defines the trigger events. Wording that is too general creates conflicting interpretations and opens the door to disputes, especially when the company is under pressure.

Generally, the trigger is an issue of securities at a lower price than the reference price defined for the protected investor. However, the agreement must also define what is actually being compared: a price per share, a price per security, or an implied value that takes preferential rights into account. The agreement must also specify whether a “gross” price is compared or a price adjusted for certain benefits.

Most often, the clause also provides for exclusions, because certain issues should not trigger the protection: incentive plans, free shares, options, automatic conversions, or specific issues linked to incentive mechanisms. Without explicit exclusions, the clause may be triggered in cases nobody had anticipated.

Ratchet implementation techniques: issue, transfer, conversion

Implementation depends on the legal structure and the type of securities. In principle, the company does not “create” securities by a mere contractual decision. It must comply with the applicable governance and issue rules, which often means transactions governed by corporate law.

The shareholders’ agreement may provide for compensation through a reserved issue of securities, a transfer by the founders, or an adjustment through securities giving access to the capital already provided for. Each option has its consequences: cash burden, dilution, formalities, and acceptability to new investors.

In some configurations, a mechanism that is activated automatically through the securities documentation (for example, an adjusted conversion) is preferred, because it reduces dependence on voluntary action by the founders. In others, a promise to transfer shares is used, but only if it fits cleanly into the company’s internal rules and the overall consistency of the agreement.

Friction point no. 1: founder dilution

The most frequent criticism concerns dilution. A ratchet mechanically transfers shareholding to the protected investor, at the expense of the others. This transfer can tip the balance of control and shift the balance of power in governance.

The risk grows when several successive rounds include similar protections. A clause that is acceptable in round 1 can become explosive in round 3. The founders then discover that the “small” initial concession costs much more than expected, because it adds up with other preferential rights, and because the company no longer has the same negotiating leeway.

That is why a ratchet is generally framed by clear limitations: duration, cap, exclusions, conditions for participating in the next round, and how it fits with the other clauses of the shareholders’ agreement.

Friction point no. 2: the deterrent effect on next-round investors

An investor coming in at round N wants to finance the future, not repair the past. If the ratchet “eats” a substantial part of the round, the new investor considers that its money is funding compensation rather than a trajectory. It then asks either for a further cut in valuation, for additional rights, or for a restructuring of the cap table before investing.

Most often, this results in lengthy negotiations, a greater risk of the deal falling through, or demands for a clean-up of the capital structure. An overly aggressive ratchet clause can therefore, paradoxically, weaken the company’s ability to raise funds when it needs them most.

To limit this effect, a proportionate formula, consistent exclusions and a mechanism that does not create a “double penalty” in a down round are preferred.

Drafting a “defensive” clause: what must be set out in black and white

A shareholders’ agreement withstands crises when it defines simple, verifiable terms. A defensive ratchet clause generally specifies: (1) the reference price, (2) the transactions concerned, (3) the exclusions, (4) the formula, (5) the practical arrangements, and (6) the treatment of borderline cases.

In particular, the clause must define how it treats complex instruments: preference shares, warrants, convertible bonds, or instruments that include adjustments. It must also explain how it handles combined transactions, for example a fundraising with several classes of securities issued simultaneously.

Finally, it must specify who calculates the adjustment, on what data, within what time limit, and with what challenge mechanism. Without this framework, the clause turns into a debate, then into a dispute, just when the company needs clarity.

Ratchets and capital increases: how they fit together in practice

In many companies, activating the ratchet leads, directly or indirectly, to an issue of securities. That issue must then fit within the corporate decisions and the delegations provided for, which brings in the framework of capital increases (in French).

The shareholders’ agreement must not promise the impossible. It must remain compatible with the company’s ability to carry out the transaction and with internal procedures. In practice, an obligation to act, arrangements for the votes and undertakings of cooperation from the parties are often provided for. Drafting a mechanism that assumes unrealistic decisions in a period of tension is also avoided.

A good habit is to reread the clause as if you were the day after a down round: who decides, who signs, who convenes, who calculates, who issues, and what happens if a party refuses to cooperate? This “stress test” reading eliminates many dangerous formulations.

What happens if the clause is not complied with?

Where a clause is valid and enforceable, failure to comply with it in principle triggers the usual contractual remedies: specific performance, damages, or mechanisms provided for in the shareholders’ agreement. In reality, the question rarely remains theoretical, because it concerns ownership of the securities and control of the company.

Most often, the dispute arises from a disagreement over the trigger, the calculation, or the characterisation of an “excluded” transaction. It may also arise from a practical impossibility of performance, for example if the transaction in question was not structured to allow the adjustment to be made in proper conditions.

Defensive drafting aims precisely to reduce these grey areas. It provides for a calculation process, a time limit, mandatory disclosure and coordination with capital transactions. It avoids absolute promises and prefers operational, testable wording that is consistent with governance.

The most common safeguards against a “toxic” clause

A clause can protect an investor without destroying the balance of the shareholders’ agreement. To that end, safeguards are generally included. They vary with the context, but some come up often in negotiations.

The first safeguard is to limit the clause in time, for example until a specific round or for a defined period. The second imposes a behavioural condition: the protected investor must participate in the next round to benefit from the adjustment. The third sets a cap on compensation, in order to contain maximum dilution.

Detailed and consistent exclusions are also provided for, in particular for issues linked to incentive plans. Finally, how the ratchet fits with the other clauses of the agreement is clarified, because a ratchet combined with other mechanisms can produce an unexpected cumulative effect.

Ratchet, shareholders’ agreement and overall consistency: the classic mistake

The classic mistake does not come from a poorly chosen formula. It comes from a clause chosen without reading the agreement as a whole. A ratchet clause does not operate in isolation: it interacts with liquidity rights, preferences, anti-dilution provisions, exit clauses and governance mechanisms.

For example, aggressive economic protection combined with broad veto rights can make the company hard to run. A poorly coordinated clause can also create counterproductive incentives, where some players prefer a downside scenario because it triggers favourable compensation.

The soundest approach is to reread the shareholders’ agreement as an architecture. If a clause produces a gain for one player, it must remain acceptable to the others; otherwise it will come back as a problem in the next round, just when the company needs speed.

When should you refuse a ratchet?

There is no universal answer. Nevertheless, certain signals often lead to refusing or substantially renegotiating. This is the case if the company faces uncapped potential dilution, or if the clause is triggered by ordinary transactions such as incentive tools.

This is also the case if the clause prevents the company from carrying out a future round on reasonable terms. A ratchet that makes later financing almost impossible becomes a systemic risk, even if the current round is signed.

Finally, if the documentation leaves too many grey areas, the clause can become a source of lasting deadlock. At that stage, a corporate lawyer helps bring the clause back into an operational framework, compatible with governance and future transactions.

Focus: avoiding the blind spot of “equivalent transactions”

Many disputes stem from how a transaction is characterised. Is it a new issue? A conversion? A restructuring? An intermediate transaction with several instruments? The shareholders’ agreement must anticipate these cases, because modern structures multiply the ways of accessing the capital.

Wording such as “any transaction having a similar effect” without a definition is generally avoided. It seems protective, but it triggers endless discussions. It is preferable to list the categories of transactions and add a tightly drawn interpretation clause, with concrete criteria.

This precision reduces the risk of conflict when the company has to act quickly. It also protects the directors, because it clarifies the framework for performance without depending on a third party’s opportunistic reading.

What founders must understand before signing

Signing a ratchet means accepting a redistribution rule in an unfavourable scenario. It should therefore be assessed in the same way as an insurance policy: in which cases it is activated, at what maximum cost, and with what consequences for control.

You also need to measure the psychological effect on the next round. Even a moderate ratchet sends a signal: “the previous investors asked for protection”. This is not necessarily negative, but it influences perception and future negotiation.

Finally, the shareholders’ agreement should be reread as a living contract. Clauses that are too harsh are rarely renegotiated in good conditions. They are renegotiated when the company needs money, and therefore when it is negotiating from a position of weakness. A proportionate, clear and sustainable mechanism is preferable.

A final word on contractual discipline in fundraising

In principle, a shareholders’ agreement takes effect because the parties freely accepted it, and because they must perform it in good faith. In a fundraising, speed sometimes pushes parties to sign clauses without “stress-testing” them. That is precisely where difficulties arise.

A ratchet clause can protect a fundraising round and stabilise an investor’s commitment. If poorly calibrated, it can also weaken subsequent rounds and create uncontrolled dilution. The difference rarely lies in a single sentence. It lies in overall consistency, the precision of the triggers, the exclusions, the caps and the performance mechanics.

If you want to understand how a ratchet clause provided for in a new fundraising round can interact with other sensitive clauses of the shareholders’ agreement, you need to think in terms of architecture: a protection only has value if it remains compatible with future growth and the company’s ability to finance its next stages.

Definition and basic principles of the ratchet clause

A ratchet clause allows initial shareholders to adjust their cost price when the company carries out an issue of new securities at a price lower than the one they paid. This economic anti-dilution protection is frequently requested by those who invest in a fast-growing company. It does not maintain their percentage shareholding in the face of every issue: it compensates for the fall in the price per share.

In general, ratchet clauses vary from one contract to another. They all rest on an adjustment designed to compensate the first investors for the economic effect of an issue at a reduced price. These adjustments may take the form of an allotment of new shares at a nominal price or a reduction in the purchase price of the additional shares.

Types of ratchet clause

Full ratchet

A full ratchet is a strict form of protection in which the price of the first investors’ shares is fully adjusted downwards if new shares are issued at a lower price. Take a simple example: an investor bought shares at €10 each, then new shares are issued at €5. Its shareholding is then recalculated as if it had paid €5 per share.

In concrete terms, the company allots it additional shares to make up the difference: in the example, its number of shares doubles. Its shareholding in the capital therefore increases, at the expense of the founders and unprotected shareholders.

Partial ratchet

Unlike the full ratchet, a partial ratchet offers a less rigid approach. Here, the price of existing shares is adjusted not fully but partially, according to a formula defined in the shareholders’ agreement. The formula may involve an average of the prices of the various share issues in order to find a compromise between the initial issue price and the new reduced price.

This type of clause therefore moderates the dilutive effects while giving the founders some room for manoeuvre in future fundraising rounds, which is often taken into account in legal discussions on the strategic choice between an equity fundraising and one using bonds convertible into shares (Obligations Convertibles en Actions, OCA). You will find more information in the article on intellectual property protection and fundraising.

Legal aspects of the ratchet clause

A ratchet clause appears in a shareholders’ agreement: it has contractual force and does not need to be approved by the general meeting to exist. Its implementation, however, most often involves an issue of new securities. In a société anonyme (SA, French public limited company), only the extraordinary general meeting has authority to decide on a capital increase, whether immediate or deferred, and it may delegate that authority (Article L. 225-129 of the French Commercial Code (Code de commerce) (in French)). The shareholders’ agreement must therefore organise the votes needed to ensure the clause is performed, for investors and for the issuers of securities alike.

Drafting this clause carefully in the shareholders’ agreement limits ambiguities and later disputes. A corporate lawyer helps all the stakeholders understand the terms and conditions attached to this clause.

Advantages and drawbacks for the various players

For investors, the advantages of such a clause are clear. In addition to anti-dilution protection, it limits the effect of an issue at a reduced price on the value of their investment. In periods of falling valuations, it acts as financial protection.

For entrepreneurs and companies, this type of clause can sometimes pose challenges. Although it makes it easier to obtain financing, it can also limit financial flexibility and lead to greater dilution of the founders’ interests. Strategic thinking is therefore needed before including such a component in fundraising rounds.

Practical examples of the ratchet clause in use

Take the example of a technology start-up in a phase of rapid growth. During its Series A, the company attracts several institutional investors who negotiate a ratchet clause in the shareholders’ agreement. If the start-up later goes through a difficult period, resulting in a new issue of securities at a much lower price during the Series B, the Series A investors will then benefit from an adjustment: additional securities will be allotted to them to bring their cost price closer to the new price.

Investor	Series A (initial price)	Series B (new price)	Additional securities (full ratchet)
Investor A	€10	€5	Number of shares recalculated as if the investment had been made at €5 (twice as many shares)

A ratchet clause may also appear in financing agreements between a listed company and investment funds. It does not protect against a fall in the share price: it applies only where there is a new issue at a price lower than the agreed reference price.

The ratchet clause is therefore an important aspect to consider when structuring fundraising rounds and other financial transactions. Well prepared, it can reassure investors while allowing companies to access the capital they need for growth. However, particular attention should be paid to its drafting in order to reconcile the diverging interests of the various stakeholders.