The extra shares lower the IPO price they are counted at, so the share count has to be solved, not divided. Worked on an illustrative 100.0 growth round.
An IPO ratchet gives the investor extra shares at listing so that its stake is worth at least a guaranteed multiple of its cost at the IPO price. On an illustrative 100.0 investment for 10.0 per cent with a 1.5x ratchet, an IPO that values the company at 1,200.0 requires 1.4286 million extra shares, lifting the stake to 12.50 per cent and the investor from 120.0 to 150.0. The extra shares lower the price they are counted at, so the share count must be solved, not divided.
Worked in full in The Growth Equity Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Ratchets appear in late-stage and growth rounds where the investor is paying close to a public-market valuation and the main exit is a listing. A liquidation preference protects the investor in a sale; it does nothing in an IPO, where preferred stock converts to ordinary shares. The ratchet fills that gap. For everyone else on the cap table it is a dilution that only bites when the IPO disappoints.
| Input | Value |
|---|---|
| Investment | 100.0 |
| Price per share paid | 20.00 |
| Investor's shares | 5.0 |
| Fully diluted shares after the round | 50.0 |
| Post-money valuation / investor's stake | 1,000.0 / 10.0% |
| Ratchet: guaranteed value at the IPO price | 1.5x = 150.0 |
| IPO pre-money equity value, base case | 1,200.0 |
The IPO value is the equity value the bookbuild puts on the existing company before any new primary shares. The ratchet binds whenever the investor's 10.0 per cent is worth less than 150.0, that is below an IPO value of 1,500.0, or a price of 30.00 a share on the original count.
IPO price on the original count = 1,200.0 ÷ 50.0 = 24.00
Investor's value = 5.0 × 24.00 = 120.0, 1.20x, short of the 150.0 guaranteed
The extra shares x are issued to the investor before the listing, so the IPO value is spread over 50.0 + x shares. The investor needs (5.0 + x) of them to be worth 150.0:
(5.0 + x) × 1,200.0 ÷ (50.0 + x) = 150.0
x = (T × S − n × V) ÷ (V − T) = (150.0 × 50.0 − 5.0 × 1,200.0) ÷ (1,200.0 − 150.0) = 1.4286 million
IPO price = 1,200.0 ÷ 51.4286 = 23.33; investor: 6.4286 × 23.33 = 150.0, a 12.50% stake
In Excel: =MAX(0,(T*S-n*V)/(V-T)).
The other shareholders held 1,080.0 of the IPO value before the ratchet and 1,050.0 after: a transfer of 30.0, and a price per share 2.8 per cent lower for everyone selling or being marked at the listing.
| IPO value | Without ratchet | Extra shares (m) | IPO price | Investor stake | Others keep | Transfer |
|---|---|---|---|---|---|---|
| 800.0 | 80.0 (0.80x) | 5.38 | 14.44 | 18.8% | 650.0 | 70.0 |
| 1,000.0 | 100.0 (1.00x) | 2.94 | 18.89 | 15.0% | 850.0 | 50.0 |
| 1,200.0 | 120.0 (1.20x) | 1.43 | 23.33 | 12.5% | 1,050.0 | 30.0 |
| 1,400.0 | 140.0 (1.40x) | 0.40 | 27.78 | 10.7% | 1,250.0 | 10.0 |
| 1,500.0 | 150.0 (1.50x) | 0.00 | 30.00 | 10.0% | 1,350.0 | 0.0 |
| 1,600.0 | 160.0 (1.60x) | 0.00 | 32.00 | 10.0% | 1,440.0 | 0.0 |
The ratchet is a floor, not a participation: above 1,500.0 the investor gets its 10.0 per cent like everyone else. Below it, the investor's payoff is flat at 150.0 and the whole shortfall lands on the other holders. At an IPO 20 per cent below the round's 1,000.0 post-money, the investor still books 1.50x and the stake nearly doubles. Over a three-year hold at the 1,200.0 IPO, the ratchet turns a 6.3 per cent IRR into 14.5 per cent.
| Guarantee | Extra shares (m) | IPO price | Investor | Transfer |
|---|---|---|---|---|
| 1.00x | 0.00 | 24.00 | 120.0 | 0.0 |
| 1.25x | 0.23 | 23.89 | 125.0 | 5.0 |
| 1.50x | 1.43 | 23.33 | 150.0 | 30.0 |
| 2.00x | 4.00 | 22.22 | 200.0 | 80.0 |
Negotiating point: founders and earlier investors usually push for a cap on the extra shares, a sunset after which the ratchet lapses, or a right for the company to pay the shortfall in cash. Each turns an open-ended dilution into a bounded one, and each is worth pricing with the table above.
The common mistake is to compute the extra shares at the pre-ratchet price: 150.0 ÷ 24.00 = 6.25 million, so 1.25 million extra. But issuing them moves the price to 23.41, and the investor ends up with 146.3, short by 3.7. In the documents the extra shares are counted at the actual IPO price; when you model the ratchet from an equity value, that price depends on the share count. The circularity is small at a modest shortfall and large at a deep one; at 800.0 the naive method misses badly. Solve the equation, or iterate the share count until the price stops moving.
The second mistake is to treat the ratchet as a liquidation preference. It is the opposite in timing: a preference pays in a sale and falls away at listing, while the ratchet only operates at listing. How the preference side behaves is worked in at what exit a 1x non-participating preference converts.
An IPO ratchet makes the investor whole to a guaranteed multiple by issuing shares that dilute everyone else, and the number of shares has to be solved because it changes the price: 1.4286 million here, not 1.25. The guarantee is worth nothing in a good IPO and a great deal in a soft one. A blank model set, three cases and the book's reserve workbook are in the free companion files.
A protection in a late-stage or growth round: if the company lists at a price that values the investor's shares below an agreed multiple of its cost, the investor's preferred converts into more ordinary shares to make up the gap. Here a 1.5x ratchet on 100.0 protects 150.0 of value at the IPO, which binds at any IPO pre-money value below 1,500.0.
Every other shareholder, through dilution. At a 1,200.0 IPO value the ratchet lifts the investor from 120.0 to 150.0, so the founders, employees and earlier investors share 1,050.0 instead of 1,080.0, and the IPO price per share falls from 24.00 to 23.33. At 800.0 the transfer is 70.0 and the investor's stake nearly doubles to 18.8 per cent.
Solve for the extra shares x so that the investor's shares, n plus x, times the IPO value V, over the enlarged count S plus x, equals the target T: x = (T times S minus n times V) / (V minus T). With 5.0 million of 50.0 million shares, T of 150.0 and V of 1,200.0, x is 1.4286 million.
This article is one calculation from The Growth Equity Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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