Broad-Based Weighted Average Ratchet

If you like the idea of moving the goal posts while a field goal attempt is in progress, then you’re gonna love this.

Phat Katz, Inc. (PKI) has preferred stock that can be converted into common shares at a set price of $50 per preferred share. In an effort to diversify and get fatter, PKI decides to issue more preferred stock so it can raise the money needed to buy Wakanda Corp., but fears that the stock market will have a negative reaction and drive down the price of common shares from $25 to $20.

If that happens, a preferred shareholder’s ability to convert would increase from two shares of common to two-and-a-half shares, thus diluting the existing shareholders.

So, PKI employs a broad-based weighted average ratchet to adjust the conversion price from $50 to $40, in order to protect against the dilution and proceed with its acquisition.