Author: Aditya Pareek | EQMint | Business News
Startup fundraising is often celebrated as a sign of growth, validation, and future success. But behind every term sheet lies a set of clauses that can dramatically reshape the ownership structure of a company—sometimes without founders fully realizing the consequences. One of the most devastating examples is the Full Ratchet anti-dilution clause, a term that has quietly crippled many founders’ ownership stakes during tough times.
Recently, a cautionary story resurfaced in the startup community: a founder who once held 51% of their company suddenly saw their ownership fall to 18%, not because of mismanagement or lack of effort, but because of one clause they didn’t fully understand.
How the Full Ratchet Clause Works
Anti-dilution clauses exist to protect investors when a startup raises money at a lower valuation—a down round. There are two common types:
- Weighted average anti-dilution (fair and widely accepted)
- Full ratchet anti-dilution (extreme, rarely used by reputable VCs today)
With full ratchet, if a company raises a new round at a lower price per share, the earlier investor’s shares are automatically repriced to match the new lower valuation, regardless of how many shares are issued.
This means investors effectively receive free shares to maintain the economic value of their investment—while the dilution falls almost entirely on the founder and existing employees.
The Real Example: From $2 Per Share to $0.20
In the case being discussed, the startup initially raised funding at $2 per share. Later, due to market challenges and reduced leverage, the company raised another round at just $0.20 per share—a massive valuation drop.
Normally, this would dilute everyone proportionally.
But because of the full ratchet clause, early investors got their entire investment revalued at the new lower price. They received additional shares for free, drastically diluting the founder’s ownership.
The result?
- Founder ownership before down round: 51%
- Founder ownership after down round: 18%
A staggering, overnight collapse in control and decision-making power.
Why Did This Happen? Lack of Leverage + Hidden Terms
Good VCs typically avoid full ratchet clauses because they create misalignment, unfairness, and long-term friction within the company.
But these clauses still appear when:
- Startups are desperate for capital
- Founders lack leverage
- Investors hold more negotiating power
- Companies fail to attract quality institutional funding
- Founders do not have strong legal guidance
In these situations, founders often sign term sheets quickly, focusing on survival rather than long-term consequences.
That’s when clauses like full ratchet slip through unnoticed.
The Hidden Truth: You Don’t Lose Equity Overnight — You Lose It When You Sign the Terms
The founder didn’t lose their ownership at the moment of the down round.
They lost it months or years earlier when they signed an agreement they didn’t fully understand.
Startup funding is not just about the amount you raise—it’s also about the terms behind that money. A single line in a contract can:
- Reprice shares
- Shift voting rights
- Change liquidation preferences
- Affect board control
- Impact your ability to raise future rounds
Many founders get excited about the funding number and ignore everything else, only to regret it later.
Why Full Ratchet Is So Dangerous
Full ratchet clauses:
- Create massive founder dilution
- Punish companies for raising money during tough times
- Scare away future investors
- Put founders at risk of losing control
- Can even make startups uninvestable
Worst of all, they disproportionately impact early-stage founders who don’t have access to experienced legal advisors.
The Current Trend: Fewer Good VCs Use It, But It’s Not Gone
Most reputable venture capital firms today avoid full ratchet because:
- It damages long-term relationships
- It harms the company’s cap table
- It reduces incentives for founders and teams
- It signals desperation
However, in markets with tightening capital or during economic slowdowns, some investors still push these clauses when founders have limited options.
This is especially common in:
- Bridge rounds
- Emergency funding
- Distressed companies
- Pre-bankruptcy situations
In those moments, founders may accept terms they never would have during better times.
The Lesson for Every Founder
Equity is the most valuable asset a founder has. Losing it due to a clause you didn’t understand is one of the most painful experiences in entrepreneurship.
The key takeaways:
- Don’t sign term sheets without expert legal review
- Understand every dilution-related clause
- Avoid full ratchet if at all possible
- Negotiate for weighted-average anti-dilution
- Know that the cheapest money can often be the costliest in the long run
- Build leverage before raising—traction is your best negotiating tool
At the end of the day, the difference between owning 51% of your company and 18% isn’t luck—it’s terms.
For more such information visit EQMint.
Disclaimer: This article is based on information available from public sources. It has not been reported by EQMint journalists. EQMint has compiled and presented the content for informational purposes only and does not guarantee its accuracy or completeness. Readers are advised to verify details independently before relying on them.
