The conversation that mattered took about eleven minutes. We had been talking to the new investor for two months, we had a term sheet in front of us, and the number on it valued the company below what we had raised at two years previously. My co-founder asked whether we should walk. The honest answer was that we had five months of runway and no better option, so the question was not whether to take a lower price but what taking it would do to everyone on the cap table.
I thought I knew. I had read the term sheet from the previous round, at the time, in the way founders read documents when the money is about to land. I had not properly understood the anti-dilution clause, and it turned out to be the single most expensive paragraph either of us had ever signed.
What a down round actually is
A down round is simply a funding round priced below the previous one. Not a failure, necessarily — it is often a correction to a valuation that was optimistic when it was set, or a reflection of a market that has repriced everything in your sector regardless of how you have performed.
The commercial effect is straightforward: new money buys more shares per pound than the last money did, so everyone already on the register is diluted more than they would have been at a flat or rising price. That much is arithmetic and applies to everyone equally.
The part that does not apply equally is anti-dilution protection, which existing preferred investors typically have and founders and employees typically do not.
Weighted average versus full ratchet
There are two mechanisms and the gap between them is enormous.
Full ratchet treats the earlier investor's original investment as though it had been made at the new, lower price, regardless of how many new shares are issued or how much money is raised. It is the most investor-friendly form and the most dilutive for everyone holding ordinary shares, founders included. It is rarely used in UK venture capital transactions, which is a fact worth knowing when someone tries to put one in front of you.
Weighted average sets a new effective price somewhere between the old higher price and the new lower one, weighted by how much new money is actually coming in. Broad-based weighted average, which counts options and convertibles in the share count, is standard UK market practice because it balances protecting the earlier investor against not wiping out the founders.
Full ratchet does not care how small the down round is. Raise £50,000 at a low price and a full ratchet reprices the entire previous round against it.
The numbers, worked through
Illustrative figures, but the mechanics are exact.
Say the company has 1,000,000 shares on a fully diluted basis before the new round: 700,000 held by founders, 200,000 by the Series A investor, and a 100,000 option pool. The Series A was priced at £5.00 a share, so that investor put in £1,000,000.
Now raise £1,000,000 at £2.50 a share. That issues 400,000 new shares.
Under a broad-based weighted average, the new effective price for the Series A investor is the old price multiplied by (shares before the round, plus the shares the new money would have bought at the old price) divided by (shares before the round, plus the shares actually issued). The new money would have bought £1,000,000 at £5.00, which is 200,000 shares. So the calculation is £5.00 × (1,000,000 + 200,000) ÷ (1,000,000 + 400,000) = £4.29.
At £4.29 a share, that investor's £1,000,000 buys 233,333 shares instead of 200,000. They receive 33,333 extra shares, issued to them at no further cost.
Under a full ratchet, the price simply resets to £2.50. Their £1,000,000 now buys 400,000 shares, so they receive 200,000 extra shares — six times as many.
Follow it through to founder ownership. Before the round the founders held 700,000 of 1,000,000, or 70%. With weighted average, the total becomes 1,433,333 and the founders hold 48.8%. With full ratchet, the total becomes 1,600,000 and the founders hold 43.75%. Five percentage points of a company, transferred by the choice between two phrases in a document signed two years earlier.
Ours was weighted average, which is the only reason this article is not considerably angrier. Anyone reading a term sheet for the first time should treat the anti-dilution clause with the same attention as the valuation itself — the six clauses worth understanding properly covers the rest of them.
The bit nobody mentions: what it does to your team
The cap table is the visible damage. The invisible damage is to the people holding share options, and it landed on us about a fortnight after completion when a senior hire asked, quite reasonably, what her options were now worth.
Options granted under EMI have an exercise price set at or above the agreed market value of the shares at the date of grant. Set it below that value and the option loses the capital gains treatment that makes EMI worth having, with income tax and potentially National Insurance falling on the discount at exercise instead. So the exercise price cannot be quietly adjusted downwards on the existing grants.
Which means that after a down round, options granted at the old higher valuation are underwater: the exercise price is above what a share is now worth. They are not worthless in the long run, because the company may recover past that price, but they have stopped functioning as an incentive today. People who joined for equity notice.
The usual answer is a fresh grant at the new, lower agreed market value. Getting HMRC to agree a share valuation before granting gives certainty on the exercise price, and after a down round that agreement is more important than usual precisely because the number has moved for reasons that need explaining. Cancelling and regranting has its own consequences that need proper advice before anyone signs anything.
There is one piece of genuinely good news here, and it arrived this year. From 6 April 2026 the EMI limits were substantially widened: the employee cap rose from 250 to 500, the company gross assets limit from £30 million to £120 million, and the total value of shares that can be placed under EMI option from £3 million to £6 million. The maximum period an option can remain unexercised without losing the tax advantages extended from ten years to fifteen. The individual limit stays at £250,000 of market value at grant. For a company that has just repriced downwards and needs to regrant meaningfully to a wider group, that headroom matters. How EMI options work sets out the basics.
What I would do differently
Four things, in the order they would have helped.
Read the anti-dilution clause at the round where it is granted, not at the round where it bites. It is negotiable when you have a term sheet in hand and entirely non-negotiable two years later. Broad-based weighted average is the standard; anything more aggressive should be traded for something real.
Model the down round while things are going well. We had never once run a cap table scenario at a lower price, because nobody builds the model where their own valuation falls. Half an hour in a spreadsheet would have told us exactly what our floor was, and we would have negotiated differently.
Talk to the option holders before they work it out themselves. We waited, and the silence read as either ignorance or evasion. Neither was true and both were worse than the actual news.
And separate the two questions the round is really asking. The first is whether you need the money, which is about runway and is usually answerable in an afternoon. The second is whether these are the right terms, which is about who owns the company in five years. Conflating them under time pressure is how founders end up signing things they do not understand — the same pressure that shows up when an investor goes quiet during due diligence.
We are three years past it now and the company is worth more than it was at the round before the down round. The dilution is permanent, the lesson is cheap in retrospect, and I still think about eleven minutes in a meeting room where the only question anyone asked was about the valuation.
Common questions
What is a down round?
A down round is a funding round priced below the previous one, so new investors pay less per share than the last set of investors did. It is not necessarily a sign of failure — it often reflects an earlier valuation that was optimistic, or a sector-wide repricing that has nothing to do with how the company has performed. The commercial consequence is that the new money buys more shares per pound, so everyone already on the register is diluted more heavily than they would be at a flat or rising price. The additional consequence, which falls unevenly, is that existing preferred investors with anti-dilution protection receive extra shares to compensate them.
What is the difference between full ratchet and weighted average anti-dilution?
Full ratchet treats an earlier investor's whole original investment as though it had been made at the new lower price, regardless of how much new money is raised. It is the most investor-friendly and the most dilutive for founders and other ordinary shareholders, and it is rarely used in UK venture capital deals. Weighted average sets a new effective price between the old and new prices, weighted by the size of the new round relative to the existing share count. Broad-based weighted average, which includes options and convertibles in that count, is standard UK market practice. On the same numbers, full ratchet can issue several times as many free shares as weighted average.
What happens to employee share options in a down round?
Options granted at the previous higher valuation become underwater, meaning the exercise price is above what a share is currently worth, so they stop working as an incentive even though they retain long-term value if the company recovers. The exercise price on existing EMI options cannot simply be reduced, because an EMI option must be granted at or above the agreed market value at the date of grant; setting it lower forfeits the favourable tax treatment and brings income tax on the discount at exercise. The usual response is a fresh grant at the new, lower agreed market value, ideally with a valuation agreed with HMRC in advance.
What changed for EMI schemes from April 2026?
The eligibility limits widened substantially. The employee cap rose from 250 to 500, the company gross assets limit rose from £30 million to £120 million, and the total value of shares that can be placed under EMI option rose from £3 million to £6 million. The maximum period an option can remain unexercised without losing the tax advantages extended from ten years to fifteen. The individual limit is unchanged at £250,000 of market value at grant. Separately, the requirement to notify each individual EMI grant to HMRC is being removed for options granted on or after 6 April 2027, though annual Employment Related Securities returns will still be required.
