Are Investors Changing The Rules For Start-up Founders?


    Investors are developing new systems that guarantee them an advantage, and a secured position in the investment arena.

    There is a paradigm shift going on for beginner’s level investment, and while this shift may benefit investors, it is to the detriment of start-up founders.

    More investors are now introducing the term “full ratchets” into agreements with founders. Rare breed Venture’s Mac Conwell, a venture capitalist announced this on Twitter recently putting founders on alert.

    According to Conwell; “If a company raises money in the future as a lower valuation or share price, then the earlier investors get their equity readjusted to match the new lower price.”

    As an opposing posture to the process that reduces the value of company shares when more shares in it are reintroduced (anti-dilution), full ratchets present a post investment cover to early investors in the event that portfolio company valuations plummets.

    The simple implication is that early investors can own considerably more of a company than the value of their original purchase should the company offer more shares for sale at a price lower than what it was sold for in a previous financing round.

    For example let us consider a scenario where Mr A’s early investors access 25% of the company at a projected $10 million valuation with a full ratchet. If Mr A raises more money from a $5 million valuation, the implication of a full ratchet in this situation is that Mr A may loose the decision making authority as these early investors now own 50% of the company.

    How should start-ups react to this new introduction? Investors are catching up on this new trend, and many are likely to add this strange aggressive term as a precondition for investment. Conwell advises start-up to simply run from such a predatory condition.

    Full ratchet may not necessarily be harmful all the time. If the company in question is not an early start-up. Companies looking to exit may benefit from a full ratchet. During valuation, it affords them the opportunity to balance up with investors.

    Let us consider another example of a company whose founder values it at $4 billion compared to an investors valuation at $1.5 billion. Full ratchet grants the founder access to an investor’s capital at a high valuation, and shields the investor from a lower valuation during an exit.

    This scenario guarantees a win-win for all the parties involved in the transaction.