A Down Round isn't a Death Sentence: How Startups Can Raise Money

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Tuesday, November 26, 2019

What should you be doing to ensure you're still able to secure investment in your startup if you're forced into a down round?

Article 4 Minutes

Securing investment is essential if any startup is to grow and become successful. But this is always a challenge, and sometimes circumstances outside your control mean things don't go as planned.

One of the biggest challenges can come when you're looking for investment, but your initial valuations don't match reality. This may be due to an overly-optimistic approach in the past, or changes in the industry or economy that have had a knock-on effect on your profitability, but it can result in something no entrepreneur wants - a down round.

What is a down round and should you worry?   

A down round is a funding round where your company is listed at a lower valuation than in previous rounds, so shares are being sold for a lower price. This is a position no startup founder wants to be in as it can give the impression your company is on a downward slide.

But there are many reasons why undergoing a down round isn’t the end of the world for your startup. As we've seen repeatedly over the last few years, over-valuing your business can do more harm in the long-run, and sky-high valuations that you can't match in the real world can cause their own problems later.

Over-valuation is something that's been especially prominent among Silicon Valley firms in the last few years. For instance, the troubles faced by WeWork and companies such as Uber trading well below their IPO demonstrate how it can happen to even the most talked-about firms if they get carried away with their own hype.

Therefore, there's no need to panic if your firm is forced into a down round. Yes, it's a sign that something's gone wrong, but it's not a death sentence.

"A down round merely suggests two mistakes were made - a new investor placed a high valuation on the company, and the board and CEO accepted that valuation. It’s not an indication that a thousand mistakes were made and the company is over." - David Pakman, partner at Venrock Capital.

 

So what can you do to secure funding in this situation and keep your company on the right path?

Don't let it kill your momentum

A down round can be a very difficult time for startups, both for founders and their employees. But it's vital that any feelings of negativity that will understandably be generated don't bleed into the running of the business, either in day-to-day activities or longer-term innovation and planning.

You've still got a business to run and investors to be won over, so you need to project confidence and demonstrate that you have a plan to get through this setback and show potential shareholders why you're still a good bet, even at a reduced price.

Reevaluate your position

An inevitable consequence of a down round is you may have to scale back your expansion ambitions, but that needn't necessarily be a bad thing. You should instead view this as a chance to take a deeper dive into your business and the surrounding market to identify opportunities to streamline your operations or spot where you've been over-ambitious or misread the market.

A more pared-down expansion plan may not be what you want, but if it presents investors with a better opportunity to actually see a positive return on their investment, it's unavoidable if you want to grow at all.

Don't panic

Many firms may respond to the prospect of a down round with layoffs to reduce their expenses, or accept highly unfavorable terms to secure investment, but this is something that should be avoided unless absolutely necessary. As well as sending out the wrong message to potential investors about your confidence in the business, people will still be at the heart of your firm and if you're losing their skills and passion, it can quickly make a bad situation worse.

Stay focused

It's important to stay focused on the parts of the company you can still control, such as your mission and your employees. People within the business may be equally worried about what a down round will mean for the future - especially if they’re shareholders as well. Make sure you keep them informed about what's going on and what changes are being made to your investment and growth plans.

It's also vital to be honest with employees and investors alike. This shows you're taking a realistic approach to the situation, but also helps inspire confidence in others. At such times, good leadership can be the difference between a company that survives and one that fails.

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