A down round is legal, survivable and sometimes the right call – but in India it detonates three tripwires most term sheets never mention. FEMA’s pricing floor makes some anti-dilution mechanics unenforceable for foreign investors. The income-tax rules can tax compensation shares issued at nominal value. And a stale valuation report can invalidate the round’s pricing altogether. This guide walks the legal mechanics of raising below your last price – what adjusts, what breaks, and the sequence that keeps a hard round clean.
What a down round legally is (and is not)
Nothing in Indian law prohibits issuing shares below a previous round’s price. The Companies Act requires only that a preferential allotment be priced at or above a fresh registered valuer’s report – and when the business has deteriorated, a fresh report showing a lower FMV is exactly what you get. FEMA requires new foreign money to come in at or above the currently certified FMV – not the old round’s price. A ₹500-per-share company whose fresh certificate says ₹180 can compliantly raise from foreign investors at ₹200. The pain is not the new issue; it is what the new price does to the old investors’ instruments.
Tripwire 1: anti-dilution vs the FEMA conversion floor
Existing CCPS holders carry anti-dilution: a down round adjusts their conversion ratio so each preference share converts into more equity. For foreign holders, that adjustment runs into a wall – the conversion formula was fixed at issuance and the effective conversion price cannot fall below the FMV certified on the issue date. Numbers: a foreign fund subscribed CCPS at ₹500 when issue-date FMV was ₹480. A full-ratchet clause resetting its conversion price to the new round’s ₹200 would deliver shares at 2.5× the permitted ratio – below the ₹480 floor, unenforceable against FEMA. A broad-based weighted-average adjustment on the same facts might move the effective price to, say, ₹430 – still above the floor, enforceable. This is the structural reason Indian deals standardise on weighted-average: full ratchet is not just aggressive, for foreign investors it frequently cannot be honoured. Related mechanics live in the FEMA pricing guide and the instrument comparison.
Tripwire 2: the tax on compensation shares
Where anti-dilution is implemented by issuing additional shares at face value (rather than adjusting a conversion ratio), the recipient investor gets property below Rule 57 FMV – and s.92 exposure follows on the shortfall, with no direct ruling on point. The Torque Pharmaceuticals creation-not-receipt defence (fresh allotments outside s.92) is available but unsettled; and note the asymmetry that NAV-based FMV may itself have collapsed in a genuine down round, shrinking the exposure – run the Rule 57 number before assuming a problem. Conversion-ratio adjustments inside an existing CCPS avoid the issue entirely: conversion is not a transfer (s.70), no new “receipt” occurs, and the ratio change was a term of the original instrument. Where possible, draft anti-dilution as ratio adjustment, not top-up shares. The full s.92/s.79 map is in the share-transfer tax guide.
Tripwire 3: stale paper
Down rounds happen slowly – a bridge, a failed process, a rescue term sheet – and valuation reports age along the way. AD-bank practice treats FEMA certificates older than ~90 days as stale; a Companies Act allotment priced off a report that predates a material deterioration invites challenge from both directions (minority shareholders arguing too low, revenue arguing convenience). The clean sequence: fresh registered-valuer report and fresh FEMA certificate after the rescue terms are substantially agreed, allotment within their shelf life, FC-GPR within 30 days. In fast-moving distress, date discipline is the difference between a defensible round and a compounding application – track the clocks on the deadline calculator.
The exit-side mirror: FEMA’s cap in distress
Managing the round beyond the law
Three practice notes from how Indian down rounds actually close. Ratchet negotiations: existing investors frequently waive or soften anti-dilution as part of the rescue – new leads demand it (a full-ratchet adjustment can hand insiders more of the company than the new money buys), and the FEMA floor gives foreign incumbents a face-saving reason to accept weighted average. Founder resets: down rounds usually pair with ESOP refreshes and sometimes founder top-up grants to restore motivation – run the new grants off a fresh, and now much lower, merchant-banker ESOP valuation; a silver lining of the down round is cheap option pricing for the team. Disclosure hygiene: the board minutes approving a down round should record why the price is right – the deterioration, the process run, the alternatives considered – because s.102 credit-worthiness scrutiny and future diligence both read those minutes. Case law is on the side of honest process: tribunals refuse to second-guess contemporaneous commercial judgment (Catwalk Worldwide, ITAT Mumbai 2026; Brajbhumi Nirmaan, ITAT Kolkata 2026), but only where the paper trail shows there was judgment to defend.
Facing a down round?
My Cloud Accountant sequences the valuations, tests the anti-dilution maths against the FEMA floor, and papers the round so it survives the next diligence.
Talk to an expertFrequently Asked Questions
Does a down round trigger tax for existing shareholders?
Not by itself – a fall in value is not a taxable event, and conversion-ratio adjustments inside a CCPS are not transfers (s.70). Tax risk concentrates in top-up shares issued at nominal prices (possible s.92 exposure) and in below-FMV secondaries executed alongside the round (s.92/s.79 double engine).
Can our foreign investor block the down round using its anti-dilution clause?
Anti-dilution compensates, it does not veto – blocking rights live in the reserved-matters list, where new share issues almost always sit. Expect the incumbent to negotiate: consent to the round traded against the anti-dilution adjustment actually implementable within the FEMA floor.
Is a down round a red flag for future investors?
Less than it was – the 2022–24 correction normalised them. What later diligence punishes is a messy down round: stale valuations, unresolved ratchet disputes, unfiled FC-GPRs. A cleanly papered down round with a recovering business reads as resilience.
What happens to convertible notes in a down round?
They convert at the lower of their cap and the discounted round price – which in a down round means the discount usually governs and noteholders do comparatively well. Stacked notes with different caps convert at different effective prices; model all of them before signing the rescue term sheet. See the convertible note guide.
Last reviewed: August 2026. FEM (NDI) Rules 2019 (Rules 2(k), 21); Companies Act 2013 s.62(1)(c) + Rule 13; Income-tax Act 2025 ss.70, 79, 92, 102; Income-tax Rules 2026 Rule 57.