Ratchet Clauses In NZ: Startup Fundraising And Founder Equity

If you're raising capital for your New Zealand startup, you're probably focused on the big-ticket items: how much you're raising, the valuation, and how quickly you can get the deal done.

But there's a clause that can quietly change the economics of your round (and your ownership) later on: a ratchet clause.

A ratchet clause can be completely reasonable in the right context. It can also be the kind of term that looks harmless in a term sheet, but becomes a serious problem when you hit a bump in growth or need to raise your next round at a lower valuation.

Below, we'll break down what a ratchet clause is, what a "hard ratchet clause" means in practice, how ratchets affect founder equity and the cap table, and what you can do to negotiate and document things properly from day one.

What Is A Ratchet Clause (And Why Do Investors Ask For One)?

A ratchet clause is an "anti-dilution" mechanism that adjusts an investor's effective purchase price (or conversion price) if the company later issues shares at a lower valuation than the investor originally paid.

In plain terms, it's designed to protect an investor if the company's next raise is a "down round".

Here's the typical scenario:

• You raise a seed round at a $10m valuation.
• 12?18 months later, the market has changed or growth is slower, and you raise again at a $6m valuation.
• The ratchet clause kicks in and increases the investor's ownership (or reduces the effective price they paid) to compensate for that drop.

From an investor's perspective, a ratchet clause can feel like a fair risk-management tool, especially if:

• your startup is very early-stage (limited traction or revenue),
• the valuation is aggressive, or
• there's uncertainty about the next funding milestone.

From a founder's perspective, ratchets matter because they can shift value away from founders and employees right when the company can least afford it (during tougher fundraising conditions).

Is A Ratchet Clause The Same As Dilution?

Not exactly. "Normal" dilution happens when you issue new shares and everyone's percentage ownership goes down proportionately.

A ratchet clause changes the maths. It can result in extra dilution being borne primarily by founders and other shareholders (often including your employee equity pool), because the investor is protected from some or all of the downside.

Hard Ratchet Clause vs Other Anti-Dilution Protections

Not all ratchets are created equal. The big difference is usually between a hard ratchet clause and softer forms of anti-dilution.

What Is A Hard Ratchet Clause?

A hard ratchet clause (often called "full ratchet anti-dilution") is the most investor-friendly version.

It typically means that if you later issue shares at a lower price, the investor's conversion price resets to that lower price as if they invested at the lower valuation in the first place.

That can be a big deal because it doesn't just partially adjust the investor's position - it can dramatically increase their ownership at the expense of founders and other shareholders.

What's A "Softer" Alternative?

Many deals use a weighted approach rather than a full reset. You might see "weighted average anti-dilution" language (the exact wording varies). The concept is that the adjustment depends on:

• how low the new price is, and
• how many new shares you issue at that lower price.

In practice, this can reduce the "cliff edge" effect that a hard ratchet clause can create.

What About Pay-To-Play Or Milestone Structures?

Sometimes, instead of (or alongside) a ratchet clause, parties use other risk-sharing tools, such as:

• pay-to-play (investors must participate in the down round to keep certain protections),
• milestone-based funding (money released in tranches when milestones are met), or
• tranched convertibles (where conversion or discount changes based on performance).

Which approach is "right" depends heavily on your business model, runway, and negotiating leverage - and that's where tailored advice can save a lot of pain later.

How A Ratchet Clause Can Impact Founder Equity And Your Cap Table

This is the part founders often feel only when it's too late: a ratchet clause can change your cap table outcomes even if you don't do anything "wrong". Markets change. Follow-on investors change. Timing changes.

Here are the main ways a ratchet clause can affect you.

1) It Can Trigger Extra Dilution In A Down Round

If you raise at a lower price later, a ratchet clause can cause the earlier investor to receive additional shares (or a better conversion rate), which usually means everyone else is diluted more than they would be in a standard down round.

That "everyone else" often includes:

• founders,
• co-founders who joined later,
• angel investors without the same protections, and
• your employee option pool (and therefore your ability to hire and retain key people).

2) It Can Complicate Future Fundraising

New investors will usually scrutinise existing rights and preferences. If a ratchet clause is in play, a future investor may worry that their money will effectively "subsidise" the earlier investor's protection.

In some cases, this leads to:

• pressure to renegotiate the ratchet before the next round,
• deal delays while lawyers and the cap table model catch up, or
• requests for additional founder concessions to make the round viable.

This is one reason it's worth getting the "plumbing" right early - including your Shareholders Agreement and any investor rights documents - so you're not stuck re-papering the company mid-raise.

3) It Can Undermine The Intent Of Your Employee Equity Plan

Many startups rely on equity incentives to attract great people. If a ratchet clause significantly increases investor ownership in a down round, it can reduce the real value of the equity you've promised your team.

That's also why equity structures should be coordinated with how you vest and issue founder and employee equity. If you're using staged vesting, a properly drafted Share Vesting Agreement can help keep expectations clear and avoid disputes if the company's funding story changes.

4) It Can Create Founder-Control Issues (Not Just Economic Issues)

Ratchets are economic rights, but they can lead to control consequences too.

If the ratchet triggers and the investor's ownership increases, it can shift voting power, special resolution thresholds, and investor consent rights (depending on your governance documents).

That's why it's important that your share rights and governance settings are consistent across documents like your Company Constitution and any shareholder arrangements.

Where Ratchet Clauses Usually Appear In Startup Fundraising Documents

Ratchet clauses don't always show up labelled as "Ratchet Clause" in big bold text. More often, they appear within:

• term sheets (as "anti-dilution" or "price protection"),
• share subscription or share purchase documents,
• convertible funding instruments, and
• shareholders agreements or investor rights agreements.

Term Sheets

Term sheets are often "headline" documents, but they set expectations and drive the long-form drafting. If your term sheet includes a ratchet clause, it's critical you understand how it will be implemented in the final legal documents.

If you're raising using a Term Sheet, it's worth checking (before you sign) whether the anti-dilution concept is:

• hard ratchet (full reset),
• weighted average, or
• subject to conditions and carve-outs.

Convertible Instruments (Including Notes)

Ratchet-style protections can also appear (directly or indirectly) in convertible funding structures. For example, the investor might negotiate different conversion pricing or adjustments if later valuation metrics shift.

If you're fundraising using a Convertible Note, make sure you're clear on:

• how the conversion price is calculated,
• what happens in a down round,
• whether there are caps, floors, or most-favoured-nation style adjustments, and
• how those mechanics interact with your next priced round.

Share Subscription / Share Issue Documents

In a priced equity round, ratchet mechanics often translate into rights to issue additional shares, adjust conversion rates of preference shares, or alter how certain share classes convert to ordinary shares.

If you're issuing shares to investors, the drafting in your Share Subscription Agreement (or equivalent equity documents) needs to be consistent with your cap table model. Small drafting differences can have big financial consequences later.

How To Negotiate A Ratchet Clause As A New Zealand Founder

Negotiating a ratchet clause doesn't have to be adversarial. The goal is to properly allocate risk while keeping the company fundable and the incentives aligned.

Here are practical negotiation levers founders commonly use.

1) Start By Modelling The Outcomes

Before negotiating language, you should model what the ratchet clause does in a few scenarios:

• a flat round (same valuation),
• a modest down round (e.g. 20?30% down), and
• a significant down round.

This helps you understand whether you're dealing with a manageable protection or a clause that could wipe out founder equity if things don't go perfectly.

2) Negotiate For Weighted Average (Instead Of Hard Ratchet)

If an investor proposes a hard ratchet clause, consider whether a weighted average anti-dilution mechanism would still meet the investor's concern but reduce the "all downside sits with founders" issue.

This is one of the biggest "dial settings" in these negotiations.

3) Add Carve-Outs So Normal Business Activity Doesn't Trigger The Ratchet

Many startups issue shares for reasons other than a priced fundraising round. You may issue shares:

• under an employee incentive or option pool,
• to advisers,
• as consideration in an acquisition, or
• in a small strategic partnership.

If your ratchet clause is drafted too broadly, you could accidentally trigger anti-dilution adjustments through routine growth activity.

Carve-outs (properly defined) can make sure the ratchet only applies to the specific scenario it was intended for (usually a priced down round).

4) Limit The Time Period

Another common approach is to limit the ratchet clause to a set period (for example, 12?18 months after the initial investment). That way, it protects the investor against immediate valuation risk, but doesn't hang around indefinitely.

5) Consider Linking Protection To Investor Participation

If the company needs to raise at a lower valuation, it's often because it needs runway. A "pay-to-play" style condition can help align incentives so that investors who want protection also support the company in tough conditions (rather than simply getting extra equity without contributing new capital).

6) Make Sure The Ratchet Works With Founder Arrangements

Ratchet clauses often get negotiated alongside founder and early stakeholder arrangements (like vesting, leaver provisions, and IP assignment).

If you have multiple founders, it's worth ensuring your Founders Agreement and fundraising terms aren't pulling the company in different directions (for example, one document assumes a certain cap table outcome that another document can override).

NZ Legal And Practical Considerations (So You're Protected From Day One)

In New Zealand, ratchet clauses aren't "automatically unlawful" - they're commercial terms. However, like any significant investment term, they should be drafted to work with your company's Constitution (if you have one), any shareholder arrangements, and the requirements of the Companies Act 1993 around share issues and shareholder approvals.

Here are the key legal and practical issues to keep in mind.

Director Duties And Decision-Making

When considering investor-friendly terms (including ratchets), directors should be comfortable they are complying with their duties under the Companies Act 1993 (including acting in what they believe to be the best interests of the company).

Practically, this usually means you should:

• model and document the impact of the term,
• make sure key stakeholders understand the effect on existing shareholders (including founders and any employee equity pool), and
• get proper advice before agreeing to terms that could materially affect the cap table in a future down round.

Share Class Rights And Consistency Across Documents

A ratchet clause often relies on share class mechanics (for example, preference shares that convert based on certain formulas). If your Constitution, subscription documents, and shareholders agreement don't line up, you can end up with:

• uncertainty about how the ratchet is supposed to operate,
• unexpected outcomes in your cap table, or
• lengthy disputes or delays during due diligence for a later round.

Getting the drafting consistent is one of those "do it once, do it right" steps that makes fundraising smoother as you grow.

Disclosure And Managing Shareholder Expectations

If you have existing shareholders (including friends-and-family investors), ratchet clauses can affect them too. You'll want to think about how you communicate funding terms internally so people understand what rights are being granted and what that means in a down-round scenario.

This is especially important if you're raising in stages, or if you've already promised a certain equity pool to employees.

Don't DIY The Drafting

Ratchet clauses are highly technical, and small wording changes can produce very different financial outcomes. Templates (or copied clauses from overseas documents) often don't match New Zealand company structures or your actual cap table.

It's usually far cheaper to get the clause reviewed and drafted properly now than to fix it later when:

• a new investor refuses to proceed,
• your existing investor wants to enforce the clause, or
• founders and shareholders disagree about what the clause was supposed to mean.

Key Takeaways

• A ratchet clause is an anti-dilution protection that can adjust an investor's ownership or conversion price if you raise at a lower valuation later.
• A hard ratchet clause (full ratchet) is typically the most founder-unfriendly version because it can reset pricing as if the investor invested at the down-round price.
• Ratchet clauses can significantly impact founder equity, employee equity pools, voting power, and how attractive your startup is to future investors.
• Ratchets are usually negotiated at term sheet stage, but the final outcome depends on how they're drafted into your subscription documents, Constitution, and shareholder arrangements.
• Common negotiation tools include moving from hard to weighted-average mechanisms, adding carve-outs, limiting the time period, and linking protection to participation.
• Because the drafting is technical and the consequences can be major, it's worth getting legal advice early so you're protected from day one.

Important: This article is general information only and not legal advice. If you'd like help negotiating or reviewing a ratchet clause for your next raise (or you want your fundraising documents set up properly before you go to investors), you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.