Wash-Out Round

Definition

A wash-out round, also known as a “down round” or “cram-down,” is a financing event in which a company raises capital by issuing new equity securities at a lower valuation than in previous funding rounds. This typically takes place when a start-up business has underperformed or is facing financial difficulties. As a result, the ownership percentage of existing shareholders is diluted, leading to a reduction in their shares’ value.

Phonetic

The phonetic pronunciation of “Wash-Out Round” can be represented as:wɒʃ-aʊt raʊnd

Key Takeaways

1. A Wash-Out Round is a term used in venture capital investing, referring to a financing round where new investors acquire a substantial or even controlling stake in a startup at a significantly lower valuation than earlier investors, leading to the dilution of ownership and possibly loss of control by existing shareholders.
2. Wash-Out Rounds are usually a result of the startup struggling to achieve the desired traction, profitability, or growth, prompting existing investors to lose confidence and seek an exit. This creates an opportunity for new investors to invest in the company at a considerably reduced valuation. Consequently, such a round can force founders and early investors to take a smaller share of the company or even relinquish control.
3. Although Wash-Out Rounds can be demoralizing and potentially devastating for early investors and founders, they can also provide the struggling startup with an influx of new capital, resources, and strategic guidance to help revive its operations and, ultimately, increase its chances of success. Additionally, these new investors may provide the necessary connections and expertise to facilitate the company’s growth.

Importance

The term Wash-Out Round, also referred to as a “down round” or “cram-down” , is important in the business and finance world as it signifies a situation when a struggling company secures additional investment at a lower valuation, often substantially, than in previous funding rounds. This scenario typically arises when a company has underperformed or failed to meet expectations, making it challenging to raise funds at the desired valuation. A wash-out round may lead to significant dilution of ownership for early investors and dilution of employee stock options. However, it is often a crucial lifeline for companies to obtain the necessary capital to remain operational, restructure their organization, or pivot their business strategy. In essence, the wash-out round is a pivotal financial event that underscores the importance of sustaining a company’s growth and continuing to attract investors.

Explanation

A wash-out round serves the primary purpose of rescuing struggling companies that seek additional funding, often under stringent conditions. This type of investment round is crucial for companies that have not been able to achieve their financial goals or growth targets set during previous funding rounds, which has led to a decrease in valuation. As part of the wash-out round, new investors come in to offer financial support to the company. Besides just providing funds, these new investors often bring fresh perspective, expertise, and resources that help rejuvenate the struggling enterprise, setting it back on track towards growth and profitability. Wash-out rounds are not without their drawbacks, particularly for existing shareholders and early investors, as they often face significant dilution of their ownership stake in the company. This occurs as a result of the issuance of new shares to the incoming investors at a lower valuation of the company. However, the rationale behind this approach is that existing shareholders and investors ultimately benefit from the wash-out round if it leads to a successful turnaround, allowing the company to regain its financial footing and potentially achieve a higher valuation in the future. The wash-out round is considered an essential lifeline for many businesses on the brink of financial collapse and can sometimes be the difference between success and ruin.

Examples

A wash-out round, also known as a “down round” or “cram-down” , is a financial event in which a struggling company raises additional capital by issuing new shares at a lower valuation compared to its previous funding round. This process dilutes existing shareholders’ ownership and can hurt the company’s reputation, but is required to save it from potential failure. Here are three real-world examples of wash-out rounds: 1. Foursquare:In 2016, the location-based social media company Foursquare went through a wash-out round. Faced with tough competition from other social media platforms, Foursquare was struggling and needed capital to survive. The company raised $45 million in a funding round, but its valuation dropped from over $600 million to around $250 million, resulting in the dilution of existing shareholder stakes. 2. Jawbone:Jawbone, a wearable technology company known for its fitness trackers and wireless speakers, experienced a series of down rounds between 2014 and 2016. The company initially had a valuation of approximately $3 billion, but by 2016, this was reduced to $1.5 billion due to its inability to compete with rivals like Fitbit and Apple. Jawbone eventually filed for bankruptcy in 2017 after several down rounds. 3. Blue Apron:Blue Apron, a meal-kit delivery service, faced significant challenges in 2017 due to increased competition, cost overruns, and an unsuccessful IPO. In June 2017, the company went public at a disappointing share price of $10, compared to its initial target of $15-$17. Later that year, in November, Blue Apron raised $200 million in funding at a share price of just $1.15, significantly diluting existing shareholder stakes. This down round eventually led to the departure of the company’s CEO and a general decline in public and investor sentiment.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Down Round
• Dilution
• Pre-money valuation
• Pro-rata rights
• Equity restructuring

Sources for More Information

• Investopedia
• The Business Professor
• Investing Answers
• Fincash