Down Rounds in Practice: Anti-Dilution, Preference Resets, and Pay-to-Play

This post is a technical companion to What Happens to Your Cap Table in a Down Round.

Its purpose is not to explain why down rounds matter, but to show how they are implemented in practice and how specific provisions reshape the cap table.

The examples below reflect common US and Canadian venture structures. The numbers are illustrative, not prescriptive.

---

 

What a Down Round Actually Is

A down round occurs when a company raises capital at a valuation below the price of a prior priced round.

The immediate effect is dilution from issuing new shares at a lower price.

The more consequential effects come from contractual provisions that are triggered by the lower price.

Down rounds are where dormant clauses become active.

 

What happens in a venture capital down round?

In a down round, new shares are issued at a lower price, triggering anti-dilution adjustments, pay-to-play provisions, preference reordering, and often governance changes that shift ownership and control away from common holders.

Step 1: Baseline Dilution from the New Money

Assume:

• Prior round: $20M pre-money, $25M post-money
• Investors own 20% post-money
• Founders own ~50% fully diluted

Now the company raises:

• $10M at a $15M pre-money valuation
• Post-money remains $25M

New investors receive:

• $10M ÷ $25M = 40% of the company

Existing holders are diluted accordingly.

A founder at ~50% may fall to ~30% immediately.

This dilution is visible and usually expected.

 

Step 2: Anti-Dilution Adjustments

Because the new price is lower than the prior round, anti-dilution provisions apply.

 

Broad-Based Weighted Average (Market Standard)

• The prior conversion price is adjusted downward using a formula that accounts for:
  • old price,
  • new price,
  • number of shares outstanding.
• Prior investors receive additional shares.
• Typical effect:
  • founders and common dilute an additional ~5–10%.

This adjustment happens automatically upon closing.

 

Full Ratchet (Rare, but Severe)

• The prior conversion price is reset entirely to the new round price.
• Prior investors convert as if they invested at the lower valuation.
• Result:
  • prior investors may double or triple their share count,
  • founder ownership can drop 20–40% in one round.

Full ratchet provisions are uncommon in strong markets but appear in distressed or founder-weak situations.

 

Step 3: Pay-to-Play and Preference Reordering

Down rounds often activate or introduce pay-to-play provisions.

Typical mechanics:

• Existing investors must participate in the down round pro-rata to retain preferred status.
• Non-participating investors:
  • convert to common, or
  • lose preference rights.

Consequences:

• The preference stack “cleans up,” but
• ownership and economics concentrate among investors who double down.

This often creates tension among the investor base and permanently reshapes payout priority.

 

Step 4: New Investor Structural Demands

New capital in a down round rarely comes without upgrades.

Common requirements include:

• Seniority over prior preferred series
• Participating preferences where earlier rounds were non-participating
• Enhanced control rights (board seats, vetoes, consent thresholds)

The cap table becomes layered:

 multiple preferred classes,

• different seniority levels,
• different conversion mechanics.

Even if valuation recovers later, this layering remains.

 

Step 5: Option Pool Refresh and Founder Impact

Down rounds almost always require employee retention measures.

Typically:

• option pool is refreshed pre-money,
• additional grants are issued to stabilize morale,
• dilution lands on existing holders.

In some cases, investors also seek:

• changes to founder vesting,
• accelerated repurchase rights on departure,
• or revised change-of-control economics.

By the end of the process, founders may lose 30–50% of their pre-down fully diluted ownership in aggregate.

---

 

What to Model Before Accepting a Down Round

From a purely analytical standpoint, companies should model:

• anti-dilution impact (weighted average vs ratchet),
• new preference stack and seniority,
• common proceeds at $50M / $100M / $200M exits,
• post-round board and veto structure,
• cumulative option pool dilution.

The goal is not to avoid dilution, but to understand where it concentrates.

---

 

What This Reference Is—and Is Not

This post is:

• a description of real implementation mechanics,
• a map of how provisions interact under stress,
• a companion to the conceptual Series 5 analysis.

It is not:

• negotiation advice,
• a checklist for “winning” a down round, 
• or a substitute for professional advice.

---

 

Bottom Line

Down rounds are not just lower-priced financings.

They are structural resets.

Anti-dilution, pay-to-play, preference reordering, and governance changes work together to reallocate risk away from capital and toward common.

Once implemented, these changes rarely unwind.

---

 

Down rounds do not change the rules of the game.

They reveal which rules were already written.

 

If you want next, the clean continuation is Series 6 — Exit Economics & Control, where these same structures determine who gets paid, who decides, and why many exits disappoint common holders despite strong headline outcomes.