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The founders hope that their startups will continually raise larger funding rounds at rising valuations. But unexpected challenges, such as a global health crisis or a sudden rise in interest rates, can have a significant impact on a company’s ability to maintain its ratings.
Some of these startups may have to resort to financing rounds, which are new financings at a valuation lower than the previous price of the company. While founders and investors generally try hard to avoid down rounds, contrary to popular belief, these deals don’t necessarily have a devastating impact on a startup’s future.
“Our first investment, when we started our company in 2021, was the complete epitome of a company that had to completely pivot during the coronavirus crisis,” Footwork co-founder Nikhil Basu Trivedi said on stage at TechCrunch Disrupt 2024. Their initial business was in the university housing market, which was devastated the moment the pandemic hit.
Footwork reset the company’s cap table and created a new stock options pool for the entire team, Basu Trivedi said, adding that the company’s new business, a subscription platform for restaurants called Table22, “has been able to survive and thrive from that experience.” Last week, Table22 announced $11 million Series A Led by Lightspeed Venture Partners.
Although not all companies that have to take a down round enjoy a full revival. Elliot Robinson, a partner at Bessemer Venture Partners, said on stage that if a company is struggling, “there’s a very good chance someone else in your industry or a competitor is dealing with many of the same challenges.”
Robinson encouraged startups in those positions to stay on that path. “If you’ve taken a ride down, that’s OK,” he said. “In a tough market environment, that can actually be a win. You may not see or feel it until four or six quarters later, but often times the market can open up for you if you’re willing to stick with it.”
Among the notable companies receiving strong valuations is Ramp, which was valued at $5.8 billion last year, a 28% discount from its previous price of $8.1 billion. The fintech gained some value last April when Khosla Ventures priced it at $7.65 billion.
Down rounds were not very common during the pandemic-era boom, but their prevalence as a percentage of all trades has more than doubled From 7.6% in 2021 to 15.7% In the first half of 2024, according to PitchBook data.
Startup prices fell dramatically after the US Federal Reserve raised interest rates, and many companies remain overvalued compared to their performance, said Dayna Grayson, co-founder of Construct Capital. Some of these companies may be considering diluting their shares, but for many founders, these deals are too stressful.
In a down round, employees and founders end up with a lower percentage of ownership in the company.
“I think the scariest thing for a lot of founders is how to manage morale,” Grayson said. “But you can definitely motivate people with down rounds.”
Robinson, who has guided three portfolio companies through flat or down rounds in the past year and a half, explained how investors motivated employees and executives at one of these companies to stay committed after a down round. He explained that while everyone in the company took a loss in valuation, the investors created a bonus pool to reward the entire team with cash bonuses if they could achieve 60% revenue growth over a specified time frame. Founders and senior executives will also receive additional shares in the form of stock options if they meet specific revenue targets, Robinson said.
“It allowed us to make the executive and company-wide goals very transparent,” he said, adding that it “reminded people that the underlying core business remains strong.”
The question on the minds of many venture capitalists now is what will happen with many AI companies raising capital at sky-high valuations.
“I think it would be hard to argue that there aren’t overvalued valuations in the market right now,” Grayson said.
Basu Trivedi, who has invested in several AI startups, including AI detector GPTZero, said many “AI companies have the fundamentals to justify the hype and valuations,” but later added that it is still difficult to know which AI companies Artificial will work. “Some of these categories are very competitive,” he said. “There are about 20 companies doing something really similar.”
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