Why We Shouldn’t Feel Down About Down Rounds

One of the most notable developments in the tech world in recent times has been the plethora of startups which have undertaken down rounds. This trend was starkly emphasised by research published in May, which revealed that the number of funding rounds raising capital at reduced company valuations almost quadrupled in the first quarter of 2023, compared to the previous year.

We’ve continued to see dramatic down rounds since then, and it may have caused understandable concern among some founders – especially in the wake of the soaring valuations and VC feeding frenzy that took place during the pandemic.

Some of the most prominent startups of recent years have been making headlines thanks to their down rounds. An example is Ramp, the New York-based B2B fintech which specialises in corporate cards, expense management and vendor management solutions.

Experiencing white-hot growth and attracting hefty investments since its founding in 2019, Ramp’s value shot from $1 billion to just over $8 billion between 2021 and 2022. However, in August of this year it undertook a down round which saw its valuation drop right down to $5.8 billion, albeit raising another $300 million in the process.

A month earlier, OneTrust – a leading trust intelligence cloud platform headquartered in Atlanta, Georgia – saw its valuation cut from $5.1 billion to $4.5 billion while raising $150 million in investment. This drop was all the more marked, given how the company’s value had been going up by leaps and bounds since its inception in 2016. 

Another eye-catching down round took place back in March, when online payments processing giant Stripe racked up a mammoth $6.5 billion down round which saw its valuation almost halved to $50 billion.

As a startup continues along its path from inception, growing and attracting more customers or clients, it’s generally expected that equity in the business will be sold at a higher and higher price with each progressive funding round. However, this ideal scenario doesn’t always come to pass, since a number of factors can cause the value of the business to drop rather than rise.

The landscape may become more competitive, perhaps with rival businesses becoming prominent within the specific sector. There may be a failure to meet particular sales targets, product development benchmarks or revenue growth projections. The business may lose major clients. There may be an overall decline in the sector, or there could be general economic headwinds causing investors to become more cautious and risk-averse.

Such factors may cast the startup in a very different light compared to its early days, and lead investors to quite reasonably expect a lower price tag for shares in the business.

A down round can certainly have negative ramifications for a business. It can indicate (perhaps correctly) that growth is slowing and therefore place a question mark over its longterm viability as an investment target. And, as well as potentially putting off investors, the very fact that a down round has taken place may impact staff morale and make it more challenging to recruit and retain top talent.

That said, the pessimistic perception of down rounds is evolving, partly because they have become so commonplace in the period after the mid-pandemic boom. Despite the rather negative implication of the very phrase “down round”, there should be a nuanced appreciation that, in the current climate, even companies enjoying precipitous growth can find themselves embarking on down rounds. A case in point is Ramp, which saw its revenues quadruple last year.

The fact is that down rounds are increasingly being seen as a pragmatic option in rocky economic times, and have in fact been hailed as a momentum driver for markets. At a recent Citigroup conference, Paul Abrahimzadeh – the investment bank’s co-head of equity capital markets in North America – said that a willingness by founders and executive boards to accept down rounds has helped spur a market rebound following the post-pandemic slump.

Speaking to Fortune, Abrahimzadeh said that “Boards have come around and realized that 2021 was an aberration. Less boards today are saying ‘I’m wedded to my 2021 valuation.’”

What this does mean is that expert advice is more important than ever, so that businesses can negotiate the down round rapids and secure the best possible transactions. In the words of John Collmer, global head of private capital markets at Citigroup, “Companies realize you do need an adviser in this market. Deal sizes have shrunk. You used to be able to just go out and raise an unlimited amount of money; now you really need to be precise.”

The bottom line is that times have changed since those heady days of 2021, when eye-watering valuations were the norm and investors were prepared to snap up equity at ever-increasing prices. Given how comparatively risk averse the current period is, the practical benefits of down rounds should be more widely understood.

As Yoko Spirig, CEO of equity management platform Ledgy, has put it, “With investors holding on to their cash more tightly, tech companies seeking funding are confronting the prospect of raising at a lower valuation than in previous fundraisings… For employees and companies, down rounds are just one aspect of operating in the challenging world of startups. They don’t have to be apocalyptic events.”