What's Below in Issue #50:
📰 - A look into why founders should not fear a down-round
📊 - Data behind the current spread in SAFE valuation caps
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The D-word is back in the VC landscape: Down-Rounds.
The down-round is when the valuation of a startup is lower than a previous round. This is considered worse than the equally feared flat round – where the valuation remains the same as the previous round.
Founders and VCs don’t want to hear the word and bend backward to avoid them. VCs fear the wrath of their investors when they need to admit their previous valuation was over-priced. Founders are terrified that a down-round will be the last equity they will be able to sell, and it will fully dilute them out of their positions.
With market valuations dropping everywhere, it is almost impossible to avoid them. Valuations in the secondary markets have dropped close to 50%-80%, and primary rounds are equally low across almost all sectors (except AI/ML). The question is what founders should do?
For founders that fear the down round, they will take evasive measures to ensure their next round is at least a flat round. This includes cutting costs to extend their runway as far as possible in the hopes that they can weather through the tough market. Others take venture debt to bridge the gap to the next round (often at steep terms). Some will include incredibly favorable terms such as 3x liquidation preferences to new investors to compensate for the higher valuation (in other words, artificially increasing the value by absorbing more risk).
Yet, this should not be seen as the only path. More VCs and founders have started to embrace the down round. In many ways, the private market should be seen similarly to the public market. People instinctively understand that the public market can become overvalued, and prices can drop – while the underlying company is no worse than it was before. However, this is not the case for the private market – while it should be. There are times when the market is hot and valuations can be high, but similarly, the market valuations can come down without representing a worse underlying company.
According to a study by Pitchbook, between 2008 and 2014, 1,421 companies raised a down round and only 188 of them (13%) weren't able to raise another round of fundraising or sell their company. That means that even with a down round, there is over an 87% chance of being successful!
Just as an example, Facebook (now Meta) was valued at $15B in 2007 and then had to raise a down round with a $10B valuation in 2009.
While it may be scary to think about having to lower your valuation, it is important to realize that it does not mean your startup is a failure or that you can’t lead a successful VC startup. On the contrary, it means the market was overheated and has become more realistic. Most founders with down rounds still end up successful.
Relevant Articles to Unicorn Founders' Backgrounds
NY FOUNDERS - JOIN OUR EVENT!!!
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PLEASE RSVP since the room is very limited and we want as many of our founders to join us as possible.
Data Corner
SAFE Valuation Caps Are Wild
It is always difficult to figure out what valuation cap to use when running a SAFE round. The truth is that it IS difficult since the caps are spread apart as much as they possibly can be. However, this chart can help you price the SAFE in line with the rest of the market.
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Written by Jason Kirby - https://www.linkedin.com/in/jasonrkirby
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