Down round

It costs the owners in several ways.

• Raising the same money at a lower price means selling more shares, so existing holders are diluted more.
• Earlier investors often hold anti-dilution protection. With the common broad-based weighted average version, their conversion price is adjusted downwards and they receive extra shares. A full ratchet resets their price to the new low one, which is far harsher on founders.
• Employee options with a strike price above the new share price become worthless on paper, which hurts retention.
• Customers, staff and the next investor read it as a warning sign.

Each funding round puts a price on the company. In a down round the price falls. Say a company raised money at a £40m valuation, and 18 months later new investors will only pay as if it were worth £25m. Every share sold in the new round is cheaper than the shares sold before, and the paper value of earlier investors' stakes drops with it.

A down round is not the same as the business shrinking, but it usually follows a plan that grew more slowly than the valuation assumed. A round at the same price as before is called a flat round.

• Chasing the highest valuation on offer. A high price on a slow plan sets up a down round later, and the investor terms attached to it can cost more than the price difference.
• Skipping the anti-dilution clause. Founders read the valuation and the amount raised and skim the protection terms. Between a broad-based weighted average and a full ratchet, the difference in your final stake can be large.
• Forgetting the option pool. Employee options struck at the old price may be worth nothing on paper after the round. Plan a repricing or a new grant before staff start leaving.
• Waiting too long to raise. Starting to fundraise with a few months of runway left removes any bargaining power and makes a down round more likely.
• Treating it as a verdict on the business. A down round is a price set by the market and the earlier assumptions. Some good companies take one, reset costs and grow well. The mistake is hiding it from the team instead of explaining it.
• Ignoring the alternatives. A bridge from existing investors, a smaller raise or a cost cut is sometimes cheaper than a full down round. Compare them with numbers before you decide.

• Raise at a price the next milestone can comfortably justify, not the highest number offered.
• Read the anti-dilution and liquidation preference clauses of a term sheet before signing, because they decide what a later down round costs.
• Keep enough runway that the next raise is not forced.
• Compare a small bridge round or cutting costs with a down round before accepting one.