What the @#$ Is a “Down Round”?


down1 150x150 What the @#$ Is a “Down Round”?The year is 1999 where promising dot-coms seem to be 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.

1st Round

The founders hold a total of 700,000 shares of the company. You’re eager to play so you offer to buy, on the spot, 30% of the company for $300,000 (or 300,000 new shares at $1 per share).

initial investment1 What the @#$ Is a “Down Round”?

A year later, the dot-com bubble bursts and the 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 price lower than what you’d originally paid.

2nd Round

Ken offers to invest $500,000 in exchange for 50% for the company. This works out to 1,000,000 new shares issued at $0.5 per share. Since the stock price has dropped from $1 in the 1st round to $0.5 in the 2nd round, your 300,000 shares now only worth $150,000 ($0.5/share x 300,000 shares) rather than $300,000.

follow on investment What the @#$ Is a “Down Round”?

This is called a “down round,” which results in a lower price per share and decreases the value of your holding. But neither you nor the startup has a choice – it’s either down round or down six feet under. Yea, you guys are feeling pretty down, too.

* For series, references are published in the last installment of the series.

 

  • tongyun

    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.

  • http://venturehype.com The Hyper Team @ Venture Hype

    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.

  • http://venturehype.com/angel-investing-glossary/ Angel Investing Terms | Venture Hype

    [...] What the @#$ Is a “Down Round”? [...]

  • Ricardo

    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.

  • http://venturehype.com The Hyper Team @ Venture Hype

    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.

  • crimson45

    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.

  • http://venturehype.com The Hyper Team @ Venture Hype

    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.

  • http://venturehype.com The Hyper Team @ Venture Hype

    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.

  • http://venturehype.com/martin-zwilling-of-startup-professionals-angel-investing-abc/ Martin Zwilling of Startup Professionals: Angel Investing ABC | Venture Hype

    [...] would like to know if there’s anything he’d do to prevent it. MZ: Nobody can prevent dilution, if the company gets into trouble and needs more money than planned. The alternative is to watch [...]

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