November 28, 2022

Venture Capital: Down Round Options

With valuations of many early-stage companies tumbling, some of those companies are staring at the possible need for a “down round” equity financing.  Down rounds are a hard pill to swallow for founders and existing investors, and often require companies to manage anti-dilution rights and other protections for existing investors. This Bloomberg Law article discusses some options that might be available to companies to help navigate these rights in order to clear the way for new financing. This excerpt discusses the potential willingness of existing investors to swap enhanced contractual rights for a waiver of anti-dilution protections:

Anti-dilution provisions and related shareholder rights can be negotiated if a company wishes to enter a new round of fundraising with a lower, flat, or increased valuation, or for the extension of an ongoing round. By enhancing certain contractual rights, companies can convince investors to waive anti-dilution rights, extend ongoing rounds, or even pay a higher share price despite adverse economic trends.

Recently, companies have successfully negotiated favorable terms by enhancing preferred shareholders’ rights to include warrant coverage, liquidation preferences of 2x to 3x compared to typical rates of one to one, or accruing dividends participating preferences.

Alternatively, rather than initiate a new fundraising round, which may warrant a revised valuation, a company may simply continue an ongoing round. Investors commonly allow for the extension of a round when a company has yet to achieve performance benchmarks already set. Extensions keep valuation and contractual terms static.

The article says that while down rounds are disfavored, they are sometimes in the company’s best interests, and investors may reach that same conclusion. In these situations, investors have proven willing to negotiate reductions in or waivers of anti-dilution rights.

John Jenkins