Down Round

Quick Facts

Definition: Financing at a lower valuation than the previous round

Prevalence: ~20% of rounds in 2023 were down rounds (up from ~5% in 2021)

Impact: Triggers anti-dilution provisions, significant founder dilution

Alternative terms: Pay-to-play, bridge financing, inside rounds

A down round is a financing round where a company raises money at a lower valuation than its previous round. If a company raised Series A at a $50M valuation and Series B at a $30M valuation, the Series B is a down round.

In Plain English

A down round is like selling your house for less than you paid. You need the money, but the market (investors) now values your company lower than before. It's painful for everyone—especially founders and early employees—and often triggers protective provisions that make the dilution even worse.

What Triggers a Down Round

Missed milestones: Company didn't hit growth targets
Market conditions: Overall venture market downturn
Burn rate issues: Running out of runway
Competitive pressure: Market position weakened
Previous overvaluation: Prior round was priced too high

The Cascade Effect

Down rounds trigger multiple painful mechanisms:

1. Anti-Dilution Adjustments

Previous investors' preferred stock converts at a lower price, giving them more shares:

Scenario	Series A Gets
No anti-dilution	Original shares only
Weighted average	Some additional shares
Full ratchet	Shares as if bought at new price

2. Liquidation Preference Stacking

New investors typically demand 1x (or higher) liquidation preference at the new lower valuation. The preference stack grows relative to common shareholder value.

3. Option Pool Refresh

New investors often require expanding the option pool, causing additional dilution.

4. Founder Equity Destruction

All of the above compounds to devastate founder and employee ownership:

Example:

Pre-down round founder ownership: 30%
Weighted average anti-dilution kicks in
New round raises $10M at lower valuation
Option pool expanded by 10%
Post-down round founder ownership: 12-18%

Real-World Examples

Stripe (2023)

Stripe's valuation dropped from $95B (2021) to $50B (2023)—a 47% decline. While still a massive valuation, employees who joined at the peak saw significant paper losses.

Klarna (2022)

Fintech Klarna raised at an $6.7B valuation in 2022, down 85% from its $45.6B peak in 2021—one of the most dramatic down rounds in tech history.

Instacart (2022)

Instacart cut its internal valuation from $39B to $13B before eventually going public at approximately $10B.

Negotiating a Down Round

Founders Should Consider:

Pay-to-play provisions: Require existing investors to participate or lose rights
Waiving anti-dilution: Ask prior investors to forgo adjustments
Smaller round size: Raise only what's needed
Bridge financing: Convert to equity at the next round's price
Inside round: Existing investors lead to avoid price discovery

Investor Protections Typically Demanded:

Senior liquidation preferences
Higher anti-dilution protection
Board seats or observer rights
Tighter governance provisions
Milestones for additional tranches

Pay-to-Play Provisions

Pay-to-play requires existing investors to participate in the down round or face consequences:

Conversion to common stock: Lose preferred rights
Loss of anti-dilution: Can't benefit from protective adjustments
Loss of pro-rata: Can't participate in future rounds
Loss of board seats: May lose governance rights

Pay-to-play aligns interests—investors who believe in the company keep supporting it.

Inside Rounds vs. Outside Rounds

Inside Round	Outside Round
Led by existing investors	Led by new investor
No new price discovery	Market sets the price
Potential conflicts of interest	More objective valuation
Faster to execute	More validation but harder

Inside rounds can mask the true severity of a down round—or help a company avoid one entirely.

The Psychological Impact

Down rounds are demoralizing:

Founders: Years of work seemingly erased
Employees: Options may be underwater
Board dynamics: Tension between investors
Recruiting: Harder to attract talent
Press coverage: Negative signaling

Recovery Strategies

Companies can recover from down rounds:

Focus on fundamentals: Prove the business model
Extend runway: Cut costs aggressively
Hit milestones: Execute on product/growth
Option refreshers: Grant new options at lower strike prices
Strategic alternatives: M&A may be attractive to acquirers

Practical Takeaways

For founders: A down round isn't the end, but it will hurt. Negotiate hard on anti-dilution waivers and consider pay-to-play to test investor conviction. Ensure employee equity is addressed—underwater options destroy morale.

For investors: Approach down rounds carefully. Aggressive terms may seem attractive but can destroy founder motivation. Consider whether the company has a viable path forward and structure terms that keep everyone aligned.

Anti-Dilution Provisions — What triggers in a down round
Liquidation Preference — How preferences stack against common
Cap Table — Where the damage shows up
Pro-Rata Rights — Pressure to participate in down rounds