Meaning
Shareholder clauses that adjust the equity distribution among investors and founders upon a liquidity event protect initial valuations or reward management performance. Investment rounds utilize share rachets to dynamically recalculate the final share allocation depending on the exit valuation achieved by the company. This protection ensures that the investor receives a guaranteed return or a larger equity share if the company performs below expectations.
The application of these clauses is limited to the moment of a change of control or a public offering, preventing any interim dilution of the founding team during regular operations.
Dilution Prevention
Investor protection against overvalued entry points is the primary objective of these adjustments. Under the terms of share ratchets, if the company is sold below a benchmark valuation, the conversion ratio of preferred shares increases. This mechanism shifts ownership from the common shareholders to the preferred investors, compensating them for the valuation deficit.
Exit Distribution
The settlement of these clauses occurs directly within the liquidation waterfall. When a qualifying sale takes place, the distribution model applies the share ratchets formula to determine the precise share count of each class. This calculation ensures that investors receive their contractual returns before any residual funds are distributed to the common holders.
Governance Control
Board decisions are influenced by the potential activation of these clauses.
