Meaning
Mathematical recalculation of the rate at which preferred equity converts into common equity. A conversion price adjustment typically triggers when a company issues new shares at a price lower than the previous round. This mechanism shifts the ownership balance to protect earlier investors from the impact of a falling valuation.
Price Protection
Dilution becomes more severe for the founder when these adjustments are applied following a down round. The conversion price adjustment increases the number of common shares the preferred holders will receive upon conversion. This reduces the percentage of the company held by the people who started it.
Structural Shift
Calculation methods like full ratchet or weighted average determine the intensity of the change. A full ratchet conversion price adjustment is the most aggressive form, as it sets the new price to the lowest possible mark regardless of how much capital was raised. This results in a large transfer of ownership away from the person in the operator seat.
In such scenarios, the founder might see their percentage ownership cut in half by a single transaction, requiring them to work twice as hard just to maintain their original influence over the board.
Capacity Constraint
Potential for future fundraising diminishes as the cap table becomes more complex and weighted toward the investors. The conversion price adjustment places a heavy burden on the founder to avoid any drop in valuation. This requirement forces a focus on short-term metrics to preserve the current equity structure.
