Question

An entrepreneur has 2000 shares. An angel invested $1000 for 1000 shares.  A new investor would have been willing to invest $500 for 1000 shares if there were no ratchet in the first round (a price of $0.50) per share. So the total value of the venture is $2000 and the new investor would own 25% of the value. At what price per share would the new investor be willing to invest if the first-round investor has a full ratchet?

Answer 1

Full ratchet is an anit dilution provision that protects the interest of early investors. It requires that early investors be compensated for any dilution in their ownership caused by future rounds of fund raising. A full ratchet also offers a level of cost protection should the pricing to future rounds be lower than the first round.

In the given situation, out of 2000 shares, the entreprerneur had issued 1000 shared to an angel investor for $1 per share. Therefore the investor is having 50% stake in the ccompany.

However, a new investor is willing to invest $500 for 1000 share (in case of no ratchet clause) ie., at $0.5 per share.

In fact, the valuation of the venture stands at $2,000 which means the value of 1 share will be $1 ($2,000/2000 shares).

Therefore, based on above information, it will be safer to conclude that the new investor will be willing to invest at $1 per share in case the first-round investor has full ratchet clause. It is because full ratchet clause prohibits dilution of stake of early investors. Hence, the minimum price per share for the new investor will be $1 per share.