He would have the right to convert his existing shares to $8 per share, thereby increasing his number of shares by 25% and maintaining 20% ownership. Usually, as a result of the implementation of a ratchet, those who own a fixed number of common shares suffer significant dilution.įor example, if a manager/investor had previously paid $10 per share for a 20% stake in the firm, he would then get more shares to maintain his percentage ownership in the firm if it were to issue new shares at the rate of $8 per share. When a ratchet is created, it is essential to limit the maximum entitlement of the managers by linking the amount payable to a maximum participation percentage. (Noun): Mechanical device consisting of a toothed wheel or rack engaged with.
A ratchet requires clear determination of the triggering event and the date and form of payment. (Verb): Move by degrees in one direction only 2. This is achieved by means of an anti-dilution clause, which protects the investor from a reduction in percentage ownership in a firm due to future issuance of additional stock to other entities by the firm. When a firm raises new equity capital, the existing managers/investors have the option of retaining the original proportionate ownership in the firm.
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