Fundraising · Investors

Is it bad to have a lower valuation in a follow-on round?

Abhishek verma Corporate Recruiter & Resourcing specialist

April 27th, 2017

I was reading an article about an Asian food company that raised a large round. The article mentioned that the company’s most recent round came at a lower valuation than the round it had done about a year prior. Is this common and benign or indicative that investors don’t believe the company is as valuable as it used to be?

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Jonathan C. Dunsmoor Founder of Law Office of Jonathan C. Dunsmoor

April 27th, 2017

It is generally not helpful for the company to have a "down round" because it, in theory, means things are not as growing as fast as they should be in the company whether that is number of views, clicks, customer acquisitions, it all depends on the company.


The foregoing discussion does not establish an attorney-client relationship, is qualified by the limited facts presented above, and should not be relied upon as legal advice. To obtain definitive legal advice upon which one can rely necessitates retaining an attorney who is qualified in this particular area of the law.

Hunter Ashmore

April 27th, 2017

TL;DR: It is somewhat common, but generally seen as a negative event.


I'll answer the second part of the question first: it is negative in almost every way when a company is valued lower than the previous round. The existing shareholders (investors AND employees) will suffer the brunt of the dilution. As a result, it can cause all sorts of culture problems (employees lose motivation when they see the value of their common stock wiped out for the new investors). Previous investors who do not stay in the new round may write off the investment as a loss and no longer go out of their way to support the company. It may carry a negative weight on any future fundraising, even if the company gets back on track. It simply becomes a lot of baggage the company now has to carry around.


That said, it is not necessarily a death knell - and savvy investors understand this. It is very common for it to take longer or cost more than planned to execute and see results. I have seen companies that were just starting to find their groove and see really positive growth, but they had simply run through their cash to get that point. Sometimes, a company's core thesis or resources on hand are sound, but it has to completely pivot and the new direction will require more runway. If it was widely known that the company had stumbled, the new investment round can also be spun as a positive signal that the company is regaining footing.

Henry FRSA Managing Director, Positive Profile Limited

April 27th, 2017

Yes, it's benign - like a benign tumour: it isn't very good, but it won't kill you.

Dimitry Rotstein Founder at Miranor

April 27th, 2017

I don't know how common down-rounds (as they are called) are, but yes, it happens, and it's generally bad news. The previous investors are not happy about it, to put it mildly, because their share in the company decreases (in terms of worth). Also, it's not fair that they risked more than the next investor by entering earlier, yet paid more per share. So, naturally, they want to be compensated by receiving additional shares for free. Any good investment agreement includes such condition. But now the new investor cries foul, because he paid, say for 20% of the company, but received less because of these new shares. So now he wants compensation too. The formula for calculating who receives how many additional shares is very complicated, and if not done right (which happens often) can create infinite recursive calculations, which will cause the founders to be diluted out of existence. Happened to a friend of mine once. He had like 30% of the company as a co-founder, and after a down-round suddenly found himself with just 0.1%. So yes, its bad.

Martin Omansky Independent Venture Capital & Private Equity Professional

April 27th, 2017

Usually not a good sign to have a "down round", but sometimes unavoidable. Having a down round may just be evidence of the presence of "stupid money" in the preceding round, or just an over-reach or miscalculation on valuation by the company or its advisers.

Anonymous

April 28th, 2017

My two cents is that the valuation usually follows the last money in. I have not seen the article but this could mean a lot of things! They may not have needed as much money, The original VC firm could have pulled out for the second round and sent people scattering.....etc!