Unit 31 of 54
In Progress

Down Rounds

Before the recent economic turmoils, many VC participants — including fundraising Founders — would have found it hard to believe that startup valuations go both ways. Up, but also down.

When a Company raises money at a lower valuation than the last round, the term “down round” is used.

Let’s take a recent example. 

In October 2017, VC market research firm CBInsights posted a tweet showing that Hollywood actress Jessica Alba’s The Honest Company had lost its “unicorn” status.

Losing the horn?

After raising over $200 million in five rounds, The Honest Company raised a Series E round at a reported valuation much lower than the previous Series D round: $1 billion vs. $1.7 billion or a -40% markdown.

As mentioned in prior lessons, the Honest Company’s situation seemed to be of the “grey-area” type. The series D was closed in the context of below-expectations revenue growth, a CEO replacement, and the failure of acquisition talks with Unilever. 

Down rounds often happen when the previous round was priced too high, setting unrealistic expectations on future performance.

When Fiction Meets Reality

The tech media gloated about Honest’s loss of the unicorn status.

In the hilarious HBO TV show Silicon Valley, angel investor Russ Hanneman complains about losing his access to the Billion-dollar Club — belonging instead to the Million-dollar one (“with an M, for million”.)

What Are The Impacts of Down Rounds? 

We cover anti-dilution clauses in the next few lessons. These clauses deal with the impact of down rounds on the shareholders’ equity, chiefly Founders’ dilution.

What do you think existing investors should do in a down round? How do you think Founders would react to it? Why do you believe down rounds happen in the first place?

Let us know in the Comments section below.

👀 Sources and Additional Material

Responses

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  1. When a company does a down round, existing investors may have an obligation to “write down” the value of their existing holdings in their financial statements, which can affect the fund’s fundraising efforts and perhaps even the ability of the general partners to receive distributions.

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