Definition
A down round is a financing scenario in which a company raises capital by selling its securities at a price per share that is less than the price per share paid by earlier investors. This is usually a indicator of a company’s decreased valuation. It often occurs when a company cannot achieve performance goals or when the market outlook is unfavorable.
Phonetic
The phonetic transcription of “Down Round” in International Phonetic Alphabet (IPA) is /daʊn raʊnd/.
Key Takeaways
- A Down Round is a funding round where a company’s valuation decreases compared to its previous valuation. This situation often occurs when the company is not meeting targets or expectations.
- Down Rounds can negatively impact a company’s reputation and can be demoralizing to teams. However, it can also be a necessary means of survival for the company to continue operation and develop further.
- The effects of a Down Round aren’t just felt by the company itself, but also by investors, particularly those who invested during or prior to the high valuation period. It can dilute share values and ultimately lead to substantial losses for investors.
Importance
A down round is an important business/finance term because it refers to a situation in which a start-up or private company raises capital by issuing equity at a lower valuation than in its previous financing round. This is significant because it can dilute existing shareholders and impact the ownership structure, signaling potential financial distress or a downward adjustment in the company’s valuation. It can also affect a company’s ability to raise additional funds in the future, as it may deter potential investors due to perceived risk. Overall, a down round holds important implications for the company’s performance and its stakeholder relationships.
Explanation
A down round is primarily a fundraising technique used by companies, which plays a significant role particularly in the context of start-ups and businesses seeking further investment to either expand or manage ongoing costs. A down round comes into play when a company sells its shares at a lower price per share than in previous fundraising rounds. The purpose of a down round is to raise capital to fund the operations of a business when the company is unable or opts not to raise funds at a higher valuation, which may be due to a variety of reasons such as market dynamics, company performance, and overall economic climate. The use of a down round, though not ideal for existing shareholders, can serve as a lifeline for a company in a challenging financial situation. It can prove to be an effective tool to infuse necessary capital into the business, helping management execute their operational plans, meet financial obligations or invest in growth opportunities. Even though it might lead to dilution of stake for existing shareholders, it may at times be viewed as a more viable option than taking on additional debt or facing potential bankruptcy. While a down round might indicate a down turn in business, it also reflects the strategic measures the management would take to keep the business afloat.
Examples
1. Foursquare: In 2013, Foursquare, a location technology platform, raised funding in a down round. The company had previously been valued at $760 million, but during the down round, it was valued at approximately $650 million. The devaluation was due to slower than expected growth and revenues.2. Jawbone: In 2016, the wearables company took a down round of financing. The company was once valued at $3 billion but after several product failures and declining sales, the valuation dropped significantly. This led to a down round, where new shares were offered at a price lower than that paid by previous investors. 3. Blue Apron: The meal kit service Blue Apron experienced a down round during its initial public offering (IPO) in 2017. The company had to lower its IPO price due to lower demand from investors, signalling a down round. This led to the company being valued at $1.89 billion at its public debut, down from a peak valuation of $3.2 billion.
Frequently Asked Questions(FAQ)
What is a Down Round?
A Down Round is a round of financing where investors purchase a company’s shares at a lower valuation compared to the previous round of funding.
What causes a Down Round?
A Down Round often occurs when a company has not met performance expectations, and its valuation is lowered as a result. It can also occur due to macroeconomic conditions and overall market trends too.
How does a Down Round impact existing shareholders?
In a Down Round, existing shareholders typically see their ownership diluted because new shares are being sold at a lower price than the initial purchase price.
Is a Down Round always a negative event for a company?
While it may signify challenges, a Down Round is not always negative. It can bring in necessary capital to reinvest into the company. However, it may impact investor confidence, and may make recruitment and retaining employees more difficult if stock options are included in compensation.
How often do Down Rounds occur?
The frequency of Down Rounds varies significantly and depends on many factors, including the overall state of the economy, specific industry conditions, and the performance of the individual company.
Can a company recover from a Down Round?
Yes, many companies can and do recover from Down Rounds. The key is to effectively utilize the new funding to rectify issues and accelerate growth, thereby increasing company valuation.
What is the opposite of a Down Round?
The opposite of a Down Round is an Up Round, where shares are sold at a higher valuation than the previous round.
Are there alternatives to a Down Round?
Yes, alternatives could include securing debt financing, seeking strategic partnerships, improving financial performance, or using bridge financing to get through a challenging period.
Related Finance Terms
- Equity Financing: This is a method of raising funds by selling company shares to investors. It’s directly connected to down rounds as down rounds happen mainly during equity financing when companies sell shares at a lower price than the previous round.
- Pre-Money and Post-Money Valuation: These are the valuations of a company before and after investment or financing. Down rounds often occur when investors reevaluate the worth of a company causing its pre-money valuation to be lower than the last post-money valuation.
- Dilution: This refers to the reduction in the ownership percentage in a certain company due to the issuance of more shares. This is a risk that investors face in down rounds when more shares are issued at a lower price.
- Venture Capital: This is a type of private equity and a form of financing sought by startups and small businesses expected to have long-term growth potential. It’s related to down rounds as venture capitalists are often the investors involved in these types of financing rounds.
- Convertible Notes: This is a form of short-term debt that converts into equity, usually in the context of a future financing round. It could be used in down rounds to provide a way to lend money to a company and delay setting a valuation.
