FMV Hurdles in Enforcing Anti-Dilution Rights in India

The Indian startup ecosystem, while vibrant, has faced notable headwinds in recent times, leading to a visible increase in ‘down rounds’ i.e., subsequent funding rounds at valuations lower than those in prior stages. According to the EY–IVCA Half-Yearly Report (H1 2025), investment activity in India fell by approximately 19 percent year-on-year, reflecting a broader slowdown in capital deployment. This trend continued into the latter half of 2025, with Indian startups raising only USD 2.1 billion across 240 deals in Q3 2025, marking a 38% decline compared to the same period in the previous year.

Against this backdrop, anti-dilution protection has emerged as an essential feature in investment documentation, particularly in early and growth-stage financings. These rights serve to safeguard investors against valuation erosion when companies issue shares at reduced prices, thereby preserving their economic position and mitigating the risk of disproportionate dilution. For investors, such provisions provide comfort not only by stabilizing ownership value but also by signaling disciplined investment structuring in volatile markets.

However, for non-resident investors, the enforceability of these protections is constrained by the Fair Market Value (FMV) requirement prescribed under India’s foreign investment framework. The tension between contractual anti-dilution provisions and India’s mandatory pricing regime under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”) introduces a layer of regulatory and valuation complexity that can hinder full implementation of these rights.

This article examines the nature and operation of anti-dilution rights, their commercial significance for investorsthe mechanisms through which these rights are typically given effect, and the specific challenges that arise in ensuring enforceability within India’s FMV-based regulatory regime.

Understanding the Anti-Dilution Right

Anti-dilution rights are contractual protections designed to preserve an investor’s economic position in the event of a subsequent issuance of shares by a company at a price lower than that paid by the investor in an earlier round. Typically incorporated in the shareholders’ agreement and mirrored in the articles of association, these provisions are triggered upon the issuance of new equity securities at a price below the investor’s subscription price.

The protection operates through a formula that adjusts the investor’s effective price per share or conversion ratio to compensate for the value erosion resulting from the down round. The adjustment is commonly effected using one of two methodologies:

• Full Ratchet Adjustment – under which the conversion price or subscription price is reset entirely to the new, lower issue price; and
• Weighted Average Adjustment – under which the adjustment is moderated by taking into account both the number of shares issued in the subsequent round and the reduced issue price.

In either case, the objective is to maintain the investor’s relative economic position, rather than their absolute percentage of shareholding. For long-term investors, such protection functions as a safeguard against unforeseen declines in valuation over the company’s capital-raising lifecycle. Anti-dilution provisions are a standard feature of investment documentation, particularly in early-stage and growth-stage transactions where successive rounds of financing at varying valuations are anticipated.

That said, when the investor is a non-resident, the practical operation of these rights is not unfettered. Any adjustment in price or conversion terms must comply with the FMV requirements prescribed under the NDI Rules. This FMV barrier can limit the extent to which anti-dilution provisions can be lawfully implemented, an issue explored in greater detail later in this article.

Giving Effect to Anti-Dilution Rights

In Indian practice, anti-dilution protection may be implemented through several mechanisms. The most common is a conversion price adjustment, where the conversion ratio of preference shares or other convertible instruments is recalculated based on the agreed formula. Other options include the issue of additional shares, bonus issues funded from reserves, or rights issues that allow investors to maintain or restore their ownership proportion. Sometimes, promoters or existing shareholders transfer shares to the investor to neutralise dilution.

Another method seen in practice is a change in the terms of the instrument itself, such as amending the conversion formula or reworking the pricing terms to achieve the intended economic outcome. However, this too is constrained by the FMV floor, since any change that results in a notional issue of shares below fair market value may be treated as a violation of the pricing guidelines under the NDI Rules.

The FMV Barrier and Its Impact

The FMV requirement under Rule 21(2) of the NDI Rules provides that any issue or transfer of shares to a person resident outside India must be at a price not less than the FMV determined by a SEBI-registered merchant banker or chartered accountant using internationally accepted methodologies.

This provision, designed to prevent capital flight and undervaluation, has a material effect on the enforceability of anti-dilution provisions. If a company’s FMV falls below the price at which a non-resident investor originally subscribed, the company cannot issue new shares, grant bonus shares, or alter conversion terms that would result in the investor effectively holding shares at a lower price. Even a change in the formula that produces a similar economic result would be viewed as a contravention of the pricing norms.

For example, if an investor subscribed at INR 100 per share when that represented the FMV, and the company’s FMV later falls to INR 60, it cannot legally issue shares or modify terms that reduce the effective price to INR 60. The Reserve Bank of India (RBI) has consistently reinforced that these pricing rules are mandatory and cannot be waived by agreement, as reiterated in the Master Direction on Foreign Investment (July 2024).

Accordingly, while the anti-dilution clause remains valid under contract law, it becomes unenforceable in practice to the extent that its operation breaches the FMV threshold.

Practical Considerations and Structuring Response

This legal limitation requires both companies and investors to plan proactively. One strategy sometimes adopted is to issue securities ata price marginally above FMV, creating a buffer for future adjustments that can still comply with FEMA regulations. In certain cases, parties may also enter into offshore contractual arrangements to achieve equivalent economic outcomes, provided that all Indian regulatory requirements, including FMV and Companies Act provisions, are fully complied with.

For strategic investors who typically take a longer view and are less focused on short-term performance milestones the emphasis shifts toward protecting value through governance rights, enhanced information access, liquidation preferences, and structured exit options. These mechanisms cannot fully offset valuation losses but can contain their impact within the regulatory framework.

Eventually, when valuations fall substantially below the original investment level, there is often an unavoidable transactional loss — a value erosion that cannot be reversed by any legal or contractual mechanism. At that stage, the practical focus shifts to preserving value within the applicable regulatory and legal framework.

Anti-dilution rights remain a vital component of investment documentation, signaling investor protection and discipline in capital structuring. Yet, their enforceability for non-resident investors is fundamentally limited by the FMV regime under Indian law.

Companies should therefore price with foresight, allowing room for valuation flexibility, while investors may periodically reassess the effectiveness of their rights as market conditions evolve. When valuations fall below the FMV at issuance, complete protection is generally not attainable, but with prudent structuring and ongoing review, it is possible to mitigate losses and preserve value to the extent feasible.