Ratchet Job: Investors Diluting Startup Entrepreneur and Employee Equity

Want to get a billion-plus startup valuation? Do a Ratchet Job.


CNBC reports "Square's mega-financing round late last year at a $6 billion valuation looked  impressive on paper. It was up 20 percent from earlier in the year and almost double from 2012. But there was more to the story. In order to achieve that valuation, the payments company had to promise investors in the round — including Rizvi Traverse and JPMorgan — that its eventual initial public offering would price at $18.56 a share, 20 percent above the $15.46 they were paying. Failing that, Rizvi and JPMorgan would be rewarded additional stock to make up for the difference. To summarize, Square, which is currently on the road pitching its IPO to prospective shareholders, guaranteed its latest investors a minimum 20 percent return on their investment....

In Silicon Valley, this sort of measure has been labeled a "ratchet." The headline valuation number is so important, the thinking goes, that some companies are willing to accept potentially punitive terms to gain billion-dollar-plus status at the expense of all else. But they're also diluting the equity of their hardworking employees by giving additional shares to investors....

"Entrepreneurs and CEOs are choosing to do this so they can make the company look more valuable," said Lise Buyer, founder of Class V Group, which advises companies as they're preparing to go public. "They're potentially taking money out of their employees' pockets for the sake of appearances." Want to make sure the valuation this round is much higher than your last? Accept a ratchet. Need a certain price to be worth more than a competitor? There's a ratchet for you too."


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