Down Rounds: When Your Valuation Plays Against You

Contxto – Most entrepreneurs think having a high valuation is a good thing. This is not always the case, especially since down rounds are not all that uncommon.

VC: So, what’s your proposed cap on this round?

Entrepreneur: Well, I haven’t sold anything yet, but I have three letters of intent. So, I estimate the current valuation is around $7 million dollars.

VC: Haha.

A few weeks ago I read a tweet that was spot on: “More fiction is written on Excel than Word”. I’m not hating on this. This is just the inherent nature of company valuation and even more so for pre-revenue companies.

There’s just a slight problem with this. Well, actually it is not that slight.

Many founders think that the more money they get for less equity, the better. And they’re right. However, doing this on a consistent basis is tough. Really tough. And if for some reason, you happen to miss the proposed metrics to reach a certain valuation after you already had funding, this means that your new investor will more likely ask you to do a down round or they will buy shares at a lesser price than your previous investors.

Now, think about the math for a second

What do you think that means for you and your previous investors? Well, first of all they will be diluted and, second and most importantly, their investment just lost value. So, instead of getting your investors more money, you just cost them. Congrats, bro!

There are some things you could do in order to avoid this from happening. Always be aware of your capabilities, reach, and context. I really admire strong-willed entrepreneurs, but if you’re hallucinating and your expectations fail to meet the standard range of optimistic visionaries, you become a crazy-boi.

Projecting out-of-this-world scenarios with no downside; ignoring or failing to accept existing or emerging competitors; as well as omitting important details, such as regulations, barriers of entry, and other variables, are the main causes for unachieved benchmarks and therefore, down rounds.

My suggestion is the following

Be realistic (or even slightly optimistic) and self-aware. If you’re overly optimistic you’re probably going to do a down round in your next liquidity event, and if you’re overly pessimistic (not many people are), obviously you’re gonna get a sh*t deal.

As my man, rapper Kid Ink would say: “You ain’t got no cash, you ain’t got no dollas. Let’s just be honest, let’s just be real.”

– VC