Ratchet (price reset provision)
Also called: reset, price reset, anti-dilution adjustment, down-round protection, price protection
A clause that lowers a warrant's exercise price or a convertible's conversion price if the company later issues stock at a lower price, or if the stock trades below a set level.
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How it works
A ratchet protects the holder of a warrant or convertible from later, cheaper deals. If the company issues shares (or securities convertible into shares) at a price below the holder's current price, the holder's price is adjusted downward. Some ratchets also reset on a date or on a stock price trigger, for example "on the 30th day after effectiveness, the exercise price resets to the lower of the current exercise price and the five-day average VWAP".
There are two broad formulas:
- Weighted average: the price moves down part of the way, depending on how many new shares are issued at the lower price. This is the gentler form.
- Full ratchet: the price drops all the way to the new, lower price, regardless of how small the new issuance is (see full ratchet).
Many warrant agreements also increase the number of shares exercisable when the price is lowered, so the holder's total exercise cost stays the same.
Worked example
Hypothetical: Company X has 5,000,000 warrants at $2.00 with a full ratchet and share-count adjustment. It later sells stock at $1.00. The exercise price resets to $1.00 and the warrants now cover 10,000,000 shares, doubling the warrant overhang without any new warrants being issued.
Why it matters
Ratchets can make one financing change the economics of every earlier one. They also make the potential share count depend on the company's future deal prices.
How to spot it
Look in the warrant or note exhibit for sections titled "Adjustments", "Subsequent Equity Sales" or "Price Adjustment". The guide Resets and ratchets covers the variations.
Related terms
Guides that use this term
Toxic financing · 5 min read
Resets and Ratchets: How Anti-Dilution Clauses Multiply Share Counts
Full-ratchet and weighted-average anti-dilution explained, with a worked share-count table as the price falls from $1.00 to $0.10.
Research pages · 6 min read
How to Read the Dilution Pressure Score: Score, Max Measured and Risk Levels
The seven components of Signal8's Dilution Pressure Score, why it reads as points out of points measured, and how the risk levels and lower bounds work.