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At the time of exit to the Indian arm of the Ibibo group, Redbus had an enterprise valuation of around Rs. 600 crores (USD 125 million). Do you know what was the shareholding of its two founders Phanindra Sama and Charan Padmaraju? Less than 15 percent.

Do you know why?

A startup’s valuation in subsequent rounds does not always increase – often it may decrease. This is exactly what happened in the case of Redbus. What happens when the valuation decreases and the company raises new investment? In the case of Redbus, the investors who funded the company in its first round had inserted a special clause to prevent their shareholding from being diluted, in the event the company’s valuation was lower in subsequent rounds. This clause is known as a ‘ratchet’. Essentially, if the company’s valuation in a subsequent funding round reduces, the old investor is given additional shares to bring his percentage levels on par.

Ratchets are of two kinds – full ratchet and weighted average ratchet. A full-ratchet protection entitles the previous investor to get additional shares to maintain his previous percentage of shareholding, in case the valuation in a subsequent round is lower. Every investor wants a full-ratchet, as far as possible. A weighted average ratchet on the other hand limits the number of additional shares issued to the proportion of his investment amount in comparison to the fresh investment. So, if a subsequent investor is investing six times the amount invested by the initial investor, the amount of anti-dilution shares issued to the previous investor will be reduced by a sixth – that is, the previous investor will not be restored to his original shareholding levels. This method can substantially reduce the additional number of shares issued to a new investor – and prevent dilution of founder stake.

 

Lawyers, advisors and consultants who are aware of the consequences may not be able to negotiate and eliminate the ratchet for their clients, but are able to significantly water it down to a weighted average ratchet. 

The full-ratchet clause can be extremely disadvantageous for any company (the Redbus founders had raised about 8 million in three rounds of funding, without ever hiring a lawyer for negotiating those investments.) Knowing about the implications of key clauses in term sheets and shareholder agreements can significantly impact the way you negotiate and raise investment for a company.

Depending on whom you are negotiating for, different negotiating positions can be adopted for your client (either the investor or the investee company) – however, you need to know the meaning and impact of the various clauses involved to be able to effectively negotiate.

Do you want to learn more about investment and financing decisions? Would you like to learn from industry experts, access sample templates and case studies?

• How to choose an efficient and cost-effective capital structure for a business and provide insights for making financial and capital-raising decisions. These skills are extremely useful for consultants, advisors, in-house counsels and corporate lawyers.

• How to negotiate and draft finance-related agreements

• How to assist clients through different stages of an investment transaction – from termsheet to finalization of the investment documentation and receipt of investment, including compliance requirements post receipt of investment and exit-related issues.

• Differences between financial and strategic investments and joint ventures, including variations in their documentation.

• How to perform due diligence, obtain approvals and compliance requirements in relation to financing transactions

• Foreign loans, syndicated borrowings and their advantages

• Security creation, documentation and issues surrounding the same

• Funding of non-profit ventures

• Acquire decision-making insights pertaining to listing of SMEs and large corporates

• Double taxation agreements, international taxation and investment transactions

Corporate lawyers, CAs, Company Secretaries, business consultants and other professionals can add huge value to clients by:

• Providing advisory and consultancy services and high-level strategic advice on financing transactions such as loans, investment and capital-raising

• Negotiating and drafting finance-related documentation

• Obtaining regulatory approvals

• Overseeing or performing compliance requirements and due diligence for such transactions.

Learn from industry experts, including General Counsels of large corporate groups and partners from India's best law firms such as AZB (see the list of Industry Experts here).

To know more enroll in "Advanced Certification in Investment Law and Institutional Finance"

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