After a first round of venture capital investment, many companies later find that they need additional capital, which is why they do additional rounds of financing. When the pre-money valuation is set before raising capital, the difference between the valuation of the previous round of financing and the new round determines whether you will experience up round or down round financing.
Setting up the proper paperwork for any financing round can be challenging, which is why an experienced corporate lawyer can help smooth the process for your company. When you are a start-up or your company is growing faster than you expected, venture capital financing rounds can feel overwhelming. With Priori’s extensive network of pre-vetted corporate lawyers, though, finding a lawyer to partner with during this process becomes easier.
What Is the Difference Between Up Rounds and Down Rounds of Financing?
Both up rounds and down rounds are effective ways of raising capital, but the amount of capital raised differs. If the pre-money valuation increases, it is an up round, but if it actually decreases, it is a down round. Up rounds are therefore considered to be positive indicators of growth in a company that increase the original investors’ wealth, while down rounds can significantly reduce returns and even the equity position of the company's founders. Generally, a company’s founders have more leverage in an up round, whereas investors in down rounds often ask for additional assurances, such as greater liquidation preference, anti-dilution protection in the event of future down rounds, and greater control of the company.
Impact of Up Rounds vs. Down Rounds
An up round is considered to be an indication that a company is growing and is more likely to be profitable for investors. In many cases, successful up round financing spurs market confidence, additional publicity and often actual growth.
Down rounds, on the other hand, can be an indication that a company is in trouble. Investors are indicating less confidence in the investment and growth may have slowed. Since ideally investors are looking for a significant increase in investment, they usually prefer to see a steady succession of up rounds of financing. In many cases, down rounds are demoralizing for employees of a company, especially in early stages. On the other hand, the infusion of capital can give a company the edge it needs to find a business model, rebound, and grow. Ultimately, it is better to experience a down round than to run out of capital.
Start-Ups, Over-Valuations, and Down Rounds
Recently, down rounds have become increasingly common in startups, especially in the tech world. When hype leads to massive first-round valuations, this can lead to over-valuations that eventually cannot be lived up to. When the market corrects itself, the succeeding round is a down round. Although this can be difficult when you are starting out, it’s important to realize that a down round is still an infusion of capital and may be what your company needs to ultimately succeed.
Depending on the particulars of your situation, the legal costs associated with raising a round can vary significantly. When you hire a lawyer through the Priori network, hourly rates start around $185 per hour but can range significantly higher based on certain types of experience. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and receive a free price quote from one of our lawyers.
Is down round financing bad for my company?
The impact of down round financing depends on the individual circumstances of your company’s financials. Although down rounds dilute ownership for existing investors, eating away at the value of your investment, the capital raised can eliminate the risk of going out of business and even turn a company around. Some companies bound back after a down round, eventually increasing its valuation over the first-round price.
How can a lawyer help during financing rounds?
When you are looking for financing, a lawyer can help ensure that you get both the best valuation and the smoothest process possible. They help maximize your pre-money valuation by making sure that your company has all of its documents in order and is in compliance with all relevant laws before potential investors start investigating. In addition, they represent your interests as a founder when finalizing any deal.