{"id":5664,"date":"2020-04-16T00:00:00","date_gmt":"2020-04-16T00:00:00","guid":{"rendered":"http:\/\/www-staging.carta.com\/sg\/?p=5664"},"modified":"2021-03-05T06:55:32","modified_gmt":"2021-03-05T06:55:32","slug":"how-to-handle-a-down-round","status":"publish","type":"post","link":"https:\/\/www-staging.carta.com\/sg\/blog\/how-to-handle-a-down-round\/","title":{"rendered":"How to handle a down round"},"content":{"rendered":"\r\n

On April 6, Airbnb announced a funding round of $1 billion led by Silver Lake and Sixth Street Partners<\/a>. This, paired with a reported valuation of $26 billion after a prior valuation of $31 billion, makes Airbnb\u2019s funding round one of the most notable down rounds in recent years, likely because COVID-19 has hit the hospitality industry especially hard.\u00a0<\/p>\r\n\r\n\r\n\r\n

In fundraising, a down round\u2014or raising money at a valuation that\u2019s less than your previous round\u2014is often the elephant in the room. No one wants to talk about it, but it\u2019s on everyone\u2019s mind, especially in today\u2019s economic climate<\/a>.\u00a0<\/p>\r\n\r\n\r\n\r\n

When you raise a down round, it can signal to investors and the general market that growth is slowing, which may prompt less trust in the stability and viability of your company. Furthermore, it can hit hard on employee morale and make the retention and recruiting of talent much more difficult.\u00a0<\/p>\r\n\r\n\r\n\r\n

This doesn\u2019t sound great, but it doesn\u2019t mean doom and gloom either. In this post, we explain how to handle a down round.\u00a0<\/p>\r\n\r\n\r\n\r\n

Understand what a \u201cdown round\u201d really means<\/h2>\r\n\r\n\r\n\r\n

First, it\u2019s important to understand what a down round means\u2014and what it doesn\u2019t mean.\u00a0<\/p>\r\n\r\n\r\n\r\n

Let\u2019s look at a down round in its traditional sense\u2014a lower price per share than a previous round, regardless of overall valuation<\/a> (though the valuation is presumably lower.)\u00a0<\/p>\r\n\r\n\r\n\r\n

How a down round affects prior stakeholders<\/h3>\r\n\r\n\r\n\r\n

Raising a down round negatively affects investors who purchased stock in earlier rounds where the price was higher.\u00a0<\/p>\r\n\r\n\r\n\r\n

Preferred stockholders may have anti-dilution provisions<\/a> in place, which are common. This means they will be issued more shares in order to preserve their initial investment percentage.\u00a0<\/p>\r\n\r\n\r\n\r\n

This also substantially magnifies dilution<\/a> for any investors and employees who own common stock. For investors without anti-dilution protections, their ownership percentage will be significantly decreased, and their investment will be worth less. For employees, if their shares were granted or purchased at a higher price than the down round\u2019s current price per share, they will find their shares underwater.\u00a0<\/p>\r\n\r\n\r\n\r\n

How a down round affects perception of your company<\/h3>\r\n\r\n\r\n\r\n

Down rounds can also affect the way some people perceive your company. Because it is fairly difficult to measure the success of a startup, valuation is the key metric most investors use. When there is a perceived slowdown of momentum, it can end up hurting your ability to hire and retain employees.<\/p>\r\n\r\n\r\n\r\n

Fortunately, a lot of venture investing is speculative, and valuations may mean little in terms of the actual health of your business. Down rounds can be triggered by a myriad of circumstances, from not being able to hit metrics to market-wide slowdowns\u2014much like we\u2019re seeing with Airbnb and the hospitality and travel industry right now.\u00a0<\/p>\r\n\r\n\r\n\r\n

Just because you raised a down round doesn\u2019t always mean that there\u2019s something fundamentally wrong about your business. It does mean, however, that the growth of your business and the milestones that come with it will most likely have a different timeline than expected. It also means that it’s absolutely imperative to stay the course and focus on the things that you can control in order to turn the tides.\u00a0<\/p>\r\n\r\n\r\n\r\n

Focus on aspects within your control<\/h2>\r\n\r\n\r\n\r\n

If you\u2019re facing your first down round, it can feel like the situation is completely out of your control. The good news is this is not the case at all.\u00a0<\/p>\r\n\r\n\r\n\r\n

When moving forward from a down round, the things that make the difference are what you do after the fact.\u00a0<\/p>\r\n\r\n\r\n\r\n

Take care of your employees\u00a0<\/h3>\r\n\r\n\r\n\r\n

One of the most important things you can do post down-round is ensuring that your employees have good option plans moving forward. As we mentioned previously,\u00a0 employees can find their options underwater after a down round. Plus, general perception of the company may be low, which can affect retention, morale, and hiring. Employees are the backbone of your company, and ensuring a good option plan not only aids in any financial hit your employees take, but should be considered an investment in both the present and future of your organization.\u00a0<\/p>\r\n\r\n\r\n\r\n

You have a few options if you find yourself in this situation.\u00a0<\/p>\r\n\r\n\r\n\r\n

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  1. First off, you can simply reward your employees with additional grants<\/strong>. This helps curb the loss that your employees just incurred from the down round. Plus, since these additional grants vest over time<\/a>, they help ensure that your employees remain invested in the growth of your company.<\/li>\r\n
  2. You can also reward your employees with a cash payout for stock options<\/strong>. This offers employees immediate liquidity and allows you to easily issue more shares to your investors.\u00a0<\/li>\r\n
  3. Another avenue you can take is to restructure stock options by option repricing<\/strong> or option exchanging<\/strong>. With option repricing, you lower the strike price across the board to match the new post-down-round share value. This is a simple solution that\u2019s easy to enact, and it usually doesn\u2019t require new vesting terms or the consent of option holders. Option exchanging is a bit more complicated, but it could also be a viable and useful solution for your employees. With this method, you exchange your employees\u2019 outstanding options for new equity awards such as RSUs<\/a>.\u00a0<\/li>\r\n<\/ol>\r\n\r\n\r\n\r\n

    The best direction to take varies for each company. Talk to your board of directors and counsel, and consider your organization\u2019s unique situation before enacting one of these plans for your employees.\u00a0<\/p>\r\n\r\n\r\n\r\n

    Have a creative way to finance\u00a0<\/h3>\r\n\r\n\r\n\r\n

    Given that the largest impact of a down round is a perception issue, finding new ways to encourage financial investment into your company instead of traditional methods can be a game-changer.\u00a0<\/p>\r\n\r\n\r\n\r\n

    Tranche financing<\/strong>, in particular, is one financing method you can use following a down round. Generally, tranche financing allows investors to invest in parts and give your company money over time versus all at once. In order to receive each part of the payment, your company has to hit certain milestones, be it financial or otherwise. Generally, tranche financing is very common in the biotech space or other industries that have many regulatory checkpoints,\u00a0<\/p>\r\n\r\n\r\n\r\n

    Because this is a more beneficial form of financing for investors, if you\u2019re struggling to raise, it can be a great way to fundraise. Tranche financing was popular in the post-2009 landscape when companies wanted to generate fundraising after the recession. It not only poses significantly less risk for the investor and encourages further investment within the company but, with each milestone reached, also helps restore confidence in your company\u2019s future growth and outlook.\u00a0<\/p>\r\n\r\n\r\n\r\n

    Plan for the future\u00a0<\/h3>\r\n\r\n\r\n\r\n

    Make plans that set you up for success moving forward after a down round. This will give you peace of mind and ensure you\u2019re ready to tackle any future bumps in the road.\u00a0<\/p>\r\n\r\n\r\n\r\n

    Though having a clean cap table<\/a> is a necessity at every stage of a business, ensuring that you have one should be a top priority following a down round. Cap tables<\/a> record ownership at a company, and ensuring that your cap table is clean, up-to-date, and accurate can give you a clear grasp on your financials. A clean cap table also makes it easy to give your employees\u2014who are often the most affected by cap table mismanagement\u2014fair and transparent equity compensation. Learn how Carta can help clean up your cap table here.<\/a>\u00a0<\/p>\r\n

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    Clean up your cap table<\/h3>\r\n