A joint venture startup once raised capital at a 10 million dollar valuation; two years later the new round closes at 6 million. The incoming investor buys shares markedly cheaper, and the earlier investor — although diluted in share count just like everyone else — suffers a second hit: the economic value per share falls disproportionately. That is the essence of a down-round, and the reason international term sheets always carry price-based anti-dilution protection. The catch is that when those mechanisms are imported into Vietnam, some familiar designs collide with a hard limit in the Enterprise Law that few people notice.
The two families of make-whole mechanics: full ratchet and weighted average
Full ratchet is the strongest mechanism: when a later round prices lower, the earlier investor’s conversion price or reference purchase price is reset all the way down to the new price, as if it had bought at the cheapest level. The earlier investor receives a large compensating share allotment, and the entire cost of the valuation drop lands on the founders and unprotected shareholders. Weighted average is gentler: the adjusted price is computed by a formula that also weighs the size of the low-priced issue — the more shares issued cheaply, the stronger the adjustment. The broad-based variant computes over all issued capital and options, producing a smaller adjustment than the narrow-based variant, which counts only shares outstanding.
In Vietnamese deal practice, broad-based weighted average is the most widely accepted balance point: it shields the early investor from a genuine valuation shock without punishing founders so hard that management incentives break. Full ratchet usually appears only where the earlier investor holds overwhelming bargaining power, and it carries a side risk: in the next round after that, new investors will demand equivalent protection, or an even lower valuation, to compensate for the compensating shares already issued.
The hard limit in Vietnam: par value and share architecture
The biggest collision point is share par value. Shares in Vietnam carry a par value stated in the charter (customarily 10,000 dong), and the law does not allow a make-whole mechanism to operate by “re-selling the past”: the company cannot simply issue new shares at a nominal price below par to compensate the earlier investor. Price-based anti-dilution in Vietnam is therefore usually implemented through two lawful channels: issuing additional shares to the protected investor under a separate issue resolution at a price not below par, with the number of compensating shares computed by the agreed formula; or using preference shares with an adjustable conversion price, where the number of ordinary shares received on conversion rises when the later round prices lower. Both channels require the charter and offering documents to record the mechanism from the outset; a promise sitting only in a side agreement is very hard to enforce when a General Meeting resolution is later needed for the supplementary issue.
A second limit is tax and pricing scrutiny: issuing compensating shares at a low nominal price may be examined by the tax authority as a non-arm’s-length transaction where the parties are related, and the company should prepare a file explaining the pre-agreed contractual mechanism. This is why down-round transactions in Vietnam are usually structured with an independent valuation record for the low-priced round, proving the later price was a genuine market price rather than a manufactured trigger for the make-whole.
Is a down-round targeted dilution?
Not necessarily. A down-round reflecting a lower market valuation is a normal economic event: the company missed its plan, the market fell, or the earlier round was priced too high. It becomes targeted dilution when the low-priced round is engineered: the new investor is an affiliate of the majority or the founders, the valuation has no independent verification, or the timing is chosen when the company does not genuinely need capital. The distinguishing signs are procedural: a clean down-round has an independent valuation, a competitive investor process, and a documented funding need; an engineered round is typically closed, fast, and has a single pre-selected buyer. For a minority without price protection, the main response tool remains the pre-emptive right under Article 124 of the Enterprise Law, to follow the money at the low price and average down its own cost base.
Price anti-dilution clause — a Vietnam negotiation frame
- Choose the family: broad-based weighted average is the market balance point; use full ratchet only for special reasons.
- Write the formula into the charter and offering documents, with a worked numerical example to prevent interpretation disputes.
- Design a lawful implementation channel: compensating shares by separate resolution at not below par, or convertible preference shares with an adjustment formula.
- Attach an independent valuation record for the low-priced round to defend the mechanism before tax authorities and other shareholders.
- Time-limit the protection (only rounds before a set milestone or an IPO), avoiding perpetual coverage.
Frequently Asked Questions
If the next round prices lower, what compensation do earlier shareholders get?
Only if the charter or investment documents contain price-based anti-dilution protection. The mechanism adjusts the earlier investor’s reference price down (partly or fully) toward the new round price, and the company issues compensating shares to restore its economic position. An unprotected shareholder receives no automatic compensation; its only tool is the pre-emptive right under Article 124 of the Enterprise Law to buy in at the low price.
How do full ratchet and broad-based differ?
Full ratchet resets the earlier round’s reference price all the way to the lowest new price, regardless of the new round’s size — the largest compensation and the harshest outcome for founders. Broad-based weighted average adjusts by a weighted formula whose denominator counts all issued capital and options, so the adjustment is much smaller and grows with the size of the low-priced issue. Narrow-based weighted average sits between the two poles.
Is a down-round the same as targeted dilution?
Not always. A down-round driven by the market or by business performance is a normal phenomenon. It becomes suspicious when the low-priced investor is an affiliate of the majority or the founders, when there is no independent valuation, or when the company has no real funding need yet still raises at a low price. The distinguishing test is the valuation process and the competitiveness of the round, not the falling number itself.
Do compensating shares hit the par value limit in Vietnam?
Yes, and this is the point most often missed when copying foreign term sheets. A company cannot issue shares below par value as compensation. The lawful implementations are issuing compensating shares under a separate resolution at a price not below par with quantities computed by the agreed formula, or using convertible preference shares whose conversion ratio adjusts. The mechanism must be recorded in the charter and offering documents from the start to be enforceable when the event occurs.
This article has been quality-reviewed by the FLAW AI Legal Council