The current decline in the public market is giving every startup pause. This has cause a pain point with overreaching valuations and no exit options. Many companies will come face to face with down rounds. What do down rounds really mean for founders and investors in the long run?
What is a Down Round?
The term “down round” refers to a scenario where the value of a business at a time of investment is below the value of the same business during a previous period or financing round. Normally during a down round, investors purchase equity in the business at a lower price.
Down rounds can occur due to various reasons. Common reasons include increased competition in the market, general economic or stock market declines or mostly likely an altered perception of investors on what they believe is the value of the business during the financing round.
During a down round, it is discovered that a business may require more capital than initially projected, and the business realizes that its value is less than it may have been during the previous funding round. Such a realization results in the sale of the business’ capital equity or shares at a lesser price per share.
During fundraising, companies establish some benchmarks that are used by investors to evaluate the performance of the company and derive a value for the business. Down rounds are common when the benchmarks set forth by the business are not met. The benchmarks can include the product or service development, revenue generation and profitability milestones, production output or hiring of key personnel.
Lastly, down rounds may result in the loss of confidence that investors, or the market at large, have in the business. The dilution of ownership, loss of confidence of investors and the market, and decreased company and employee morale resulting from a down round may make the business unattractive to a certain extent.
Alternatives to a Down Round
Cutting Costs and keeping more money in the bank
Raise Bridge Financing
Renegotiate with investors
Close the Business.
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Article by: Rakesh Parikh
Rakesh is a Managing Director and founding member of Pivot Capital LLC. As a registered certified public accountant, he’s spent the past 20 years in private practice as the founder of One Capital Financial Advisors, Inc. advising clients in accounting and financial services including audits, reviews, compilations, valuations, tax advice and LLCS corporate preparation. His work also includes mergers and acquisition advisor, certified exit planning advisor to small business and family partnerships as well as due diligence in buyer-side target acquisitions.