A ratchet mechanism, or equity ratchet mechanism, varies the amount of equity held by different parties. It's often used to reward good performance by management, by giving out extra shares or giving them extra value when exiting ownership. There are many different ratchet mechanisms, but most common are those triggered by exit capitalizations after the PE fund investors have reached a hurdle rate threshold. So what does this actually mean? Well, this means that once a PE fund has earned its minimum required return, any extra value still to be shared out between the shareholders can be shared more heavily towards management and their ownership stake would normally be due.

For example, at exit once a PE fund's IRR hurdle rate is reached, management receive options, giving them a greater stake. The number of options can increase as higher hurdles are reached.

This is a huge incentive to management, meaning an exit value below the IRR hurdle rate will only give them their poultry ownership stake, but an exit value over the IRR hurdle return, we'll earn them a much greater share of the company.