What the @#$ Is a “Down Round”?
Joey Lo | Jul 02, 2009
The year is 1999. The economy is hot and full of excitements and opportunities. Promising dot-coms are popping up in the blink of an eye. The startup your buddy Ken invested in quickly attracted venture capital and on it went to the IPO wonderland. Ken is handing out cigars and telling you his success stories. “I’d be crazy if I don’t get in the game now,” you thought. So you decided to play angel and throw some seed money at a sexy dot-com set up by some pretty bright college kids. You’re ready to fly.
Your initial investment:
The founders hold a total of 700,000 shares of the company. You’re eager to play so you offer $300,000 for a 30% stake* on the spot. In other words, you’re offering to buy 300,000 new shares at $1 per share.
* Obviously just an example.
A year later, the dot-com bubble bursts and your startup is no longer sexy. Luckily for you, it’s at least meeting milestones and generating a little revenue. But cash is tight and it needs to raise additional capital to survive – and it needs it fast. So you make a few calls to Ken, who later agrees to inject some cash into the startup, but at a lower valuation than what you’ve originally paid.
Follow-on investment:
Ken offers to invest $500,000 in exchange for 50% for the company. This works out to 1,000,000 new shares at $0.5 ($500,000/1,000,000 shares) per share. Since the price per share has dropped from $1 to $0.5, your 300,000 shares now only worth $150,000 ($0.5/share x 300,000 shares) rather than $300,000.
This is called a “down round.” Stocks worth less now and your initial investment has become less valuable. But neither of you has a choice – it’s either down round or down six feet under. Yea, you guys are feeling pretty down, too.
Filed Under: Angel Investing Basics • Definitions • Valuation
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Angel investing isn't for the faith of heart. Not only do you have to be prepared for the down round but you also have to treat it as if you've lost your investment right after you invested in a startup — it's that risky. But it's also very rewarding if you hit a home run.
Angel investing isn't for the faith of heart. Not only do you have to be prepared for the down round but you also have to treat it as if you've lost your investment right after you invested in a startup — it's that risky. But it's also very rewarding if you hit a home run.
Risk this is the name of the game, If your not up to it then you won't know whether it will become successful or not. You can not foresee how the economy will be in the future so you should always be ready anytime.
The purpose of this post is to define “down round.” But yes, just like investing in the stock market, it’s not recommended to put all your eggs in one basket when investing in startups. Prominent angels often have tens or hundreds of companies in their portfolio. Many of the startups they invest in will fail, that’s part of the game, but one or two home runs may be enough to cover all of their losses and generate some very handsome returns.
I suppose for most angel investors, their activity investing in any one project would ideally be just part of their portfolio…?
I'd think that diversifying would hopefully offer some protection against unforeseen obstacles like natural disasters, etc.
[...] What the @#$ Is a “Down Round”? [...]
You're absolutely right. Angel investing is rewarding but it's also risky. Not only is there possibility of down round but you'd also lose your shirt.
Unfortunately, this is one of those chances you take when you become an angel investor. There are times when you can do all of the necessary due diligence before investing with a company but for reasons beyond anyone's expectation, the market or company could go belly up. I'd suspect that if you didn't have the stomach for potential down rounds, then you shouldn't be an angel investor.