Founders want their startups to continually raise larger funding rounds while increasing their valuations. However, unforeseen challenges such as a global health crisis or soaring interest rates can significantly impact a company's ability to maintain its valuation.
Some of these startups may have to resort to down rounds, which are new financings at a lower valuation than the company's previous price. Contrary to popular belief, these deals don't necessarily have a devastating impact on a startup's future, although founders and investors generally try hard to avoid down rounds. .
“When we founded the company in 2021, our first investment was a round of down rounds for companies that had to completely pivot during the coronavirus pandemic,” said Footwork Co-Founder. Nikhil Basu Trivedi spoke on stage at TechCrunch Disrupt 2024. Their original business was in the college housing market, but it was decimated the moment the pandemic hit. ”
Basu Trivedi said the footwork reset the company's cap table and created a new stock option pool for the entire team, noting that the company's new venture, a subscription platform for restaurants called Table22, is “an experience that Somehow I survived and grew from there,” he added. Last week, Table22 announced an $11 million Series A led by Lightspeed Venture Partners.
However, not all companies that were forced into a down round fully recovered. Elliott Robinson, a partner at Bessemer Venture Partners, said on stage that if a company is struggling, “there's a pretty good chance that someone else in your field or a competitor is working on many of the same challenges.” he said.
Robinson encouraged startups in these positions to stay the course. “If I take a down round, I’m fine,” he said. “In a tough market environment, that can actually be a win. You might not see it or feel it until after four or six quarters, but if you want to stick with it, in many cases , the market will open up to you.”
Notable companies whose valuations have suffered include Lamp Corp., which was valued at $5.8 billion last year, down 28% from $8.1 billion previously. The fintech gained some of its value in April this year when Khosla Ventures priced it at $7.65 billion.
While down rounds were less common during the pandemic-era boom, the share of down rounds in all deals more than doubled from 7.6% in 2021 to 15.7% in the first half of 2024, according to PitchBook data. increased.
Dana Grayson, co-founder of Construct Capital, said that after the Federal Reserve raised interest rates, prices for emerging companies fell significantly, and many companies remain overvalued relative to their earnings. said. While some of these companies may be considering down rounds, these deals can be extremely stressful for many founders.
In a down round, employees and founders reduce their ownership in the company.
“I think the biggest fear for a lot of founders is how to manage morale,” Grayson says. “But you can absolutely incentivize people through down rounds.”
Mr. Robinson, who has led three portfolio companies to flat or down rounds in the past year and a half, advises investors how to ensure that employees and executives at one of these companies remain committed after a down round. He explained how he was motivated to do so. He explained that while everyone at the company experienced writedowns, investors set up a bonus pool that would give the entire team a cash bonus if they were able to achieve 60% revenue growth within a certain period of time. . Robinson said founders and executives will also receive additional equity in the form of stock options if they meet certain revenue targets.
“This allowed us to be very transparent about our company-wide goals and operating objectives,” he said, adding, “It reminded people that the underlying core business is still strong.”
The question on many venture capitalists' minds right now is what will happen with so many AI companies raising money at such high valuations.
“It would be difficult to argue that overvaluation does not exist in the current market,” Grayson said.
Basu Trivedi, who has invested in several AI startups including AI detector GPTZero, said many AI companies “have the fundamentals to justify the hype and valuation,” but what has happened since then? He added that it is still difficult to tell whether AI companies will succeed. “Some of these categories are very competitive,” he says. “In fact, about 20 companies are doing something similar.”