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> If you don't raise enough, and need more funding later, doing a down round is extremely painful. I hear this a lot, but I don't quite understand the sentime
by Simon_says 8y ago
> If you don't raise enough, and need more funding later, doing a down round is extremely painful.
I hear this a lot, but I don't quite understand the sentiment. It's painful for whom? The earlier investor, sure, but not the founders.
Scenario 1: I have a round of funding at $1MM valuation then later a round of funding at a $10MM valuation.
Scenario 2: I have a round of funding at $100MM valuation then later a round of funding at a $10MM valuation.
Scenario 2 has a down round, but it's unclear to me how anyone in this scenario is worse off besides the suckers who bought in at a too high valuation. They just overpaid; that's all. The business and the other shareholders are strictly better off because they were able to get more cash for the shares sold.
- PeterisP 8y agoThe investors of the that $100MM round very likely have some downside protection in the agreements, so that the following down round disproportionally dilutes all the owners before that $100MM round - the founders, initial investors, and employees.
- btown 8y agoYep, https://medium.com/@CharlesYu/the-ultimate-guide-to-liquidation-preferences-478dda9f9332 https://medium.com/@CharlesYu/the-ultimate-guide-to-liquidat... is a decent overview. An oversimplified scenario might be that if a VC invests $25mm at a pre-money $100mm valuation with a 2x liquidation preference, and the company eventually sells for say $60mm (or raises money in a down round at that valuation, which doesn't bode well for a sale price much greater than that)... then the VC would get $50mm before any other investors, including founders, could split the remaining $10mm. What was once a 20% share of the company given to that VC balloons to a 5/6 share of the company. Not fun for founders and early investors.