Meaning
Price adjustment mechanisms inside a convertible security protect investors from dilution by lowering the conversion price if subsequent rounds occur at a lower valuation. This feature is known as a safe conversion ratchet and it preserves the economic power of early capital.
Calculation Logic
Adjusting the price requires a comparison between the original cap and the new price per share. A safe conversion ratchet triggers a mathematical reset that increases the number of shares the investor receives upon conversion. This formula ensures the investor maintains a specific economic interest regardless of the decline in company value.
Dilution Protection
Protection against a down round is the primary function of this clause. Founders and early employees bear the cost of the ratchet because their own ownership is reduced to accommodate the extra shares given to the protected investor. This mechanism shifts the risk of a lower valuation from the investor to the common shareholders.
Conversion Record
Tracking the adjusted price is necessary for an accurate cap table. Each round of funding might trigger a new calculation that overrides the previous conversion price. Records must show the history of these adjustments to prove the final share count at the time of an exit.
