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.
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.