Sport England has cut funding for men's and women's rugby union by £1m-plus because of a "disappointing" drop in player numbers.
The reduction, which brings the total below £30m for 2009-2013, was agreed with the Rugby Football Union (RFU).
Sport England's chief executive Jennie Price backed the priority now being given by the RFU to the grassroots.
RFU chief executive John Steele said: "We are now committed to creating a sound [new] platform for growth."
He added: "We have to accept that the failure to meet our Sport England targets over the last few years would inevitably affect the level of funding we receive.
"However, I now believe we have far more realistic targets for the next two years... as we move towards the home World Cup in 2015."
Sport England's Active People Survey showed that the number of adults playing rugby union at least once a week has declined from 230,000 at the start of the funding period, in 2009, to 177,900 at the latest calculation.
Price explained: "The decision to reduce funding to the RFU was not taken lightly.
"But Sport England has been clear that failure to achieve the agreed growth in its sport would lead to a governing body's overall funding levels being reviewed.
"I am glad that the RFU has acknowledged that the challenge for rugby union is to stop the decline in participation - and to inspire new and former players to get out on the pitch enjoying this great game in all its forms.
"We strongly support the approach being taken by the new leadership team at the RFU, and the priority now being given to the grassroots game. Our discussions give us confidence that the very significant investment we are still making will deliver value for money."
Along with the reduction in investment, the RFU - English rugby's governing body - renegotiated a new participation goal.
Sport England said the RFU plans to recover from the "disappointing performance of 2009 and 2010 with a greater focus on all four forms of the game - 15-a-side, 7-a-side, tag and touch".
"There will also be more focus on improving the quality of rugby players' experience of the sport at all levels," a statement added.