Building your roots and surviving as a founder in this market.
The Down Round - The Elephant in the Room?
Creative ways to raise rounds and even contemplate the once frowned upon “down round.”
What is a down round?
Private companies fundraise through rounds, aiming for higher pricing as their valuation increases. When that valuation drops below the level of previous rounds they might look to a "down round." In a down round, the company will sell shares of stock to new investors at a price that is lower than its previous round(s).
In the last year as funding has become increasingly hard to secure for startups, down rounds, and other creatively structured rounds are becoming less the elephant in the room.
Just shy of 20% of all venture investments in Q1 were down rounds, the highest proportion since at least 2018. Only a year ago, a mere 5% of venture deals resulted in a decrease in valuation, and with median valuations taking a nosedive from their recent highs, companies are now in for a rough ride in their quest for a valuation increase.
What is the downside to a down round?
In days past, they had a negative view which can lead to greater dilution, loss of confidence in the company, as well as lower employee morale. However, down rounds are becoming less taboo and given the market, are becoming more of the new normal. Sometimes a down round may be the only way to survive, and with current conditions, the need for funding might outweigh any past negative drawbacks.
What are the alternatives?
There are mainly two choices for startups right now aside from a down or flat round — venture debt or a “structure” round.
Venture debt is a loan to an early-stage company that gives liquidity to a business between funding rounds.
Structured round, which a startup raises at a higher valuation but gives the investors liquidity preference that can be as high as 3x. So if the structure round leads to profitability or an exit it can make sense.
The bottom line?
“I have more respect for companies that are going to raise a down round and keep the same structure as previous ones,” said Don Butler, managing director at Thomvest Ventures. “It keeps (the cap table) cleaner.” Other investors say they never attached a stigma to down rounds, and an uptick in them helps keep them all on the same level.
Remember survival is paramount. Down-rounds typically happen due to macro-economic trends that influence valuations during the capital raise, and they do not necessarily indicate any fundamental flaws in the company.
Strong companies with capital needs can raise a down-round, continue to grow, and later raise future rounds at higher valuations. Surviving an economic downturn often positions companies as leaders in the next business cycle.
Keep the wheels on!