What is a down round?
A down round happens when a private company sells new equity at a lower price per share than in its previous financing round. In short: the company needs more capital and external investors value it less than prior backers did, so it must issue shares at a discount to the prior round’s price.
Key takeaways
– A down round is selling new shares at a lower price than the previous financing round.
– It signals a lower company valuation and typically causes greater dilution for existing shareholders.
– Down rounds can be driven by missed milestones, macro conditions, competition, or excessive burn rate.
– Investors often demand protective terms (board seats, anti‑dilution, liquidation preferences) in down rounds.
– Alternatives include bridge debt, convertible instruments, strategic partnerships, cost cuts, or M&A — but each has tradeoffs.
Source: Investopedia / Madelyn Goodnight (as provided).
Understanding down rounds — what happens and why
– Valuation change: The new financing sets a lower implied pre-money valuation than the last round. That reduced valuation is the central fact of a down round.
– Increased dilution: To raise the needed capital at a lower price per share, the company must sell more shares, increasing dilution to founders, employees (option pool), and earlier investors.
– Investor protections: New investors in a down round commonly require added protections, such as anti‑dilution provisions, liquidation preferences, board representation, and covenants to protect downside risk.
– Signaling risk: A down round publicly signals weaker growth or execution versus expectations, which can harm market confidence and morale inside the company.
– Not always failure: Down rounds may reflect temporary setbacks, broader market declines, or prudent capital-raising choices. They can also be necessary to keep a company alive and allow it to reach more value-accretive outcomes later.
Common causes
– Burning cash faster than planned (insufficient runway).
– Missing product, hiring, or revenue milestones promised to investors.
– New, stronger competitors eroding projected market share.
– Macro or sector downturns reducing investor appetite and valuations.
– Overly optimistic prior valuation (hype vs. fundamentals).
How financing mechanics and terms change in a down round
– Price per share falls: The price per share paid by new investors is lower than the prior round.
– Anti‑dilution provisions: Earlier preferred holders may have anti‑dilution rights that adjust their conversion price. Types:
– Full‑ratchet: earlier investor’s conversion price is set to the new, lower price (very dilutive to founders).
– Weighted‑average: conversion price adjusts based on a weighted average formula that considers prior shares outstanding and the new financing amount (less punitive).
– Liquidation preferences: New investors may demand 1x (or higher) preferences and participating preferences.
– Board control: New investors may request board seats or observer rights, changing governance.
– Pay‑to‑play: Investors may insist that existing holders buy pro rata in the new round or lose certain privileges.
– Option pool and employee grants: Founders may need to expand the option pool post‑round (often carved out of pre‑money), increasing dilution.
Practical steps for founders before and during a down round
1. Diagnose: get clear on the root cause(s)
– Which milestones were missed? Are they recoverable?
– Is the valuation decline due to company-specific issues or broader market forces?
2. Cash management & runway
– Tighten spending immediately to extend runway.
– Prioritize projects with fastest path to measurable traction (revenue, retention, partnerships).
3. Consider alternatives before selling equity at a lower price
– Bridge financing (convertible note or SAFE) — may postpone valuation negotiation but can create later pressure.
– Venture debt — preserves equity but typically requires revenue/collateral and covenants.
– Strategic partner or customer prepay — non‑dilutive or less‑dilutive capital.
– Cost reductions or temporary hiring freezes.
– M&A discussions or structured exits.
4. Prepare to negotiate from a position of facts
– Build a crisp data room: updated financials, KPIs, customer metrics, cohort analysis, burn schedule, and a realistic plan showing use of proceeds.
– Identify and quantify recoverable opportunities and milestones the new capital will fund.
– Decide what governance concessions (board seats, covenants) you can accept.
5. Negotiate the term sheet carefully
– Fight for weighted‑average anti‑dilution rather than full‑ratchet.
– Limit liquidation preference multiples and eliminate participating preferences if possible.
– Preserve founder voting rights by managing board composition and veto rights.
– Protect employee option pool mechanics — avoid having the full increase carved out pre‑money if possible.
– Ask for performance-based milestones rather than permanent punitive covenants.
6. Communicate with employees and stakeholders
– Be transparent about the need for financing and the strategy to rebuild value.
– Explain the implications for equity compensation and next steps (option repricing, refresh grants).
– Offer retention incentives (bonus, new grants tied to milestone achievements).
7. Legal and tax hygiene
– Use experienced counsel familiar with venture financing to ensure anti‑dilution language, pay‑to‑play clauses, and conversion mechanics are well understood.
– Consider tax implications for repriced options and employee exchanges.
Practical steps for investors evaluating a down round investment
1. Conduct deep due diligence on what changed since the last round.
2. Focus on realistic milestones the company can hit with the new capital.
3. Negotiate protective terms proportional to risk:
– Appropriate anti‑dilution (weighted average is common).
– Reasonable liquidation preferences (1x non‑participating is standard).
– Board representation, covenants, and information rights.
4. Structure staged financing where capital is released as milestones are met.
5. Consider offering operational support (board members, commercial introductions) to help restore value rather than just taking protective legal mechanisms.
Anti‑dilution example (simple numerical illustration)
– Company had 10 million shares outstanding; prior investor paid $2.00/share.
– New round price = $1.00/share.
– Full‑ratchet anti‑dilution would allow prior investor to convert at $1.00 — effectively doubling their ownership percentage at the expense of founders.
– Weighted‑average would compute a blended conversion price based on new shares issued relative to existing shares, producing a milder adjustment.
Alternatives to a down round — pros and cons
– Convertible debt or SAFE: postpones valuation negotiation; can compress future rounds and create debt-like pressure if not carefully managed.
– Venture debt: less dilutive, but requires repayments and covenants; not always available to early-stage startups.
– Strategic partnership or revenue deals: non‑dilutive, but often smaller amounts and may constrain execution.
– Cost reduction and extending runway: preserves ownership but may slow growth and harm product development or go-to-market.
– M&A or asset sale: may be the best outcome when independent financing would destroy value; preserves some return for stakeholders.
Managing employee equity and morale
– Address options that are underwater: consider option repricing or exchanges tied to new grants and performance.
– Use refresh grants and clear career/milestone-based incentives to retain key talent.
– Communicate candidly — uncertainty is worse than a sober plan.
Longer-term considerations
– A well-managed down round can buy time to rebuild traction and reach a stronger exit later.
– Repeated down rounds are erosive to ownership and morale — focus on converting the capital into sustainable improvements in product, metrics, and market position.
– Institutional investors will expect clearer governance and reporting after a down round; treat that as an opportunity to professionalize operations.
Checklist for founders preparing to raise in a weak market (or prepare for a potential down round)
– Update three‑year financial model and a 12–18 month burn/runway plan.
– Prepare a tight narrative: what went wrong, what’s fixed, what the new capital will accomplish.
– Assemble KPI dashboards and customer data for due diligence.
– Prioritize spending to extend runway to a safe negotiating position.
– Speak early and candidly with existing investors — they may lead or participate in a rescue round.
– Hire counsel experienced in anti‑dilution, liquidation preference, and governance effects.
When a down round may be the right choice
– The alternative is running out of cash and facing insolvency or an involuntary liquidation.
– If the new capital meaningfully increases the probability of a material recovery — and the terms are not catastrophically dilutive — a down round can be the pragmatic solution to preserve value for all stakeholders.
Further reading and source
This article draws on concepts and explanations from Investopedia’s “Down Round” (Madelyn Goodnight). For specific legal and financial implications, consult experienced startup counsel and your board when negotiating terms.