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Most startups will face the prospect of a lower valuation than they wanted at some point. Which is why raising too much, too early, at too high a valuation, can really backfire on an entrepreneur. The common course correction is still doing an upround, albeit at a smaller number. This article will discuss the situations when even that compromise doesn’t work.

1) Flat Round – A flat round is simply starting from the old valuation. If your last post was 20 and you are now raising 5, then your pre is 20 and your new post is 25.

Three situations when a flat round typically happens:

  • market aka terms now are overall much less favorable than before
  • timing aka you are running out of money and pressured to get it quickly
  • traction aka the progress of the company doesn’t merit a higher valuation

The caveats in doing a flat round:

  • existing investors are not rewarded for taking an earlier risk
  • employees are being diluted much more than if it was an upround
  • the company signals a weaker position to the market which may affect future financing

Most other investors will advocate for doing a stock refresher for key personnel and not publicizing a flat round.

2) Down Round – A down round is a valuation that is lower than the previous one. If your last post was 20 and you are now raising 5 but say the new post is 22.5 (17.5 pre + 5 of new money) then you have effectively done a down round. The three situations and caveats of a flat round apply to a down round too, except taking it to a further level. Ask any investor or founder and they will tell you to absolutely avoid a down round because it hurts morale, tends to attract a different mindset of investors (“vulture capitalists” rather than “venture capitalists”), and puts the company in a tougher position to raise in the future. If you are contemplating a down round then, unless you have utmost conviction of turning things around, you should really sell the company. And since a M&A process is usually the result of careful long-term planning, it’s best to engage potential acquirers at least 6 months before running out of cash.

3) Recap – A recap is when a cap table gets completely wiped away and the company is rebooted. It’s a nuclear option that should be done really when the startup has value but is not well structured. Two two most common issues are founders own too little and / or existing investors are dragging the company down. Doing a recap typically involves a supermajority to agree to it, say 2/3 of the voting shareholders. And given it will dilute all the existing shareholders to zero, the conversation around a recap is typically initiated by a new investor coming in. If you are contemplating a recap then you should seriously consider instead a spinout i.e., salvage the best assets into a new company and potentially sell others.

4) Shut Down – Shutting down a company and returning the money proportionally is not very common but it does happen. An entrepreneur may choose to do so of their own volition or perhaps forced by their board, instead of the previous three alternatives (flat round, down round, recap). A number of questions do come up: where do employees go to, what about existing contracts, who gets to keep the IP. As such, shutting down a company typically happens at a very early stage of a company’s life, when there are fewer variables to deal with. If you are considering shutting down a company then a M&A including acquihire is often the best alternative. That will usually take care of all the aforementioned questions plus allows founders and VCs to claim some kind of victory. Obviously the key is having enough time to pursue an acquisition; some of the ways to extend runway include deferring salary, trading salary for equity, and reducing salary with potentially backpay.

5) Other Variables To Play With – Valuation is hardly the only variable to play with:

  • Warrants – the right to invest at previous terms
  • Prorata – the right to invest in the future to maintain ownership
  • Super Prorata – the right to invest in the future to not just maintain but increase ownership
  • Graduated discount rate – if this round is a convertible then reward the investor for taking the risk by giving say a 15% discount if the company raises in 6 months, 15% in 9 months, 20% if it’s higher than that.
  • Change of control – if the company gets sold within certain parameters, typically time and price, then investors will get a premium.

A combination of some or all of these variables can make a round more attractive and better balance the interests of all parties.


Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.

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Amit Garg
I have been in Silicon Valley for 20 years -- at Samsung NEXT Ventures, running my own startup (as of May 2019 a series D that has raised $120M and valued at $450M), at Norwest Ventures, and doing product and analytics at Google. My academic training is BS in computer science and MS in biomedical informatics, both from Stanford, and MBA from Harvard. I speak natively 3 languages, live carbon-neutral, am a 70.3 Ironman finisher, and have built a hospital in rural India serving 100,000 people.

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