Meaning
Contractual provision that sets a minimum valuation or share price for future issuance or liquidation prevents excessive dilution of existing shareholders during a down round. Implementing an equity floor ensures that investors receive a guaranteed number of shares or a specific value regardless of market fluctuations. This clause is commonly found in term sheets for early-stage venture capital deals.
Dilution Protection
Early backers use this mechanism to maintain their percentage of ownership when subsequent rounds occur at a lower price. An equity floor provides a safety net that limits the impact of a declining company valuation on the original stakeholders.
Downward Adjustment
Price changes trigger the protection when the new round falls below the agreed threshold. Under the equity floor, the conversion ratio of preferred shares is adjusted to compensate for the lower price. This prevents the management team from issuing cheap shares to new investors at the expense of the old ones.
The math follows a weighted average or a full ratchet formula depending on the negotiation.
Pricing Mechanism
Valuation caps often work in tandem with these floors to create a range for future financing. Establishing an equity floor helps stabilize the capital structure during periods of economic uncertainty.
