Founders hope that their startups will continue to raise more funding while increasing their valuations. However, unforeseen challenges, such as a global health crisis or sudden spikes in interest rates, can have a serious impact on a company’s ability to maintain its valuation.
Some of these startups may have to resort to down rounds, raising new funding at a lower valuation than the company’s previous price. Founders and investors typically work hard to avoid downturns, but contrary to popular belief, these deals aren’t necessarily fatal to a startup’s future.
“When we started the company in 2021, our first investment was the epitome of a company that had to pivot entirely during COVID-19,” Footwork co-founder Nikhil Basu Trivedi said on stage at TechCrunch Disrupt 2024. “Their initial business was in the college housing market, which took a huge hit as soon as the pandemic hit.”
Basu Trivedi said Footwork reset the company’s cap tables and created a new pool of stock options for the entire team, adding that the company’s new business, a restaurant subscription platform called Table22, “was able to survive and grow through that experience.” Last week, Table22 announced an $11 million Series A investment led by Lightspeed Venture Partners.
However, not all companies that have suffered a downturn have achieved a complete revival. Elliott Robinson, a partner at Bessemer Venture Partners, said on stage that if a company is struggling, “there’s a very good chance that someone else in your field or a competitor is dealing with the same problem.”
Robinson encouraged startups in these positions to persevere. “If you’ve downrounded, that’s fine,” he said. “In difficult market environments, this can actually be a win. “You may not see or feel it until the fourth or sixth quarter, but there is plenty of time for the market to open up if you want to stick with it.”
High-profile companies whose valuations have taken a hit include Ramp, which was valued at $5.8 billion last year, a 28% discount to its previous price of $8.1 billion. The fintech gained some of that value in April this year when Khosla Ventures priced it at $7.65 billion.
While down rounds were less common during the pandemic-era boom, their share of overall deals more than doubled from 7.6% in 2021 to 15.7% in the first half of 2024, according to PitchBook data.
Dayna Grayson, co-founder of Construct Capital, said startup prices have fallen significantly since the U.S. Federal Reserve raised interest rates, and many companies remain overvalued relative to their performance. Some of these companies are probably considering a down round, but for many founders, these transactions are very stressful.
In a down round, employees and founders have a lower percentage of ownership in the company.
“I think the scariest thing for a lot of entrepreneurs is how to manage fraud,” Grayson said. “But you can absolutely incentivize people with a down round.”
Robinson, who has guided three portfolio companies through flat or down rounds over the past year and a half, explained how investors motivated the employees and executives of one of these companies to remain committed even after a down round. He explained that while everyone in the company was experiencing valuation losses, investors built a bonus pool to reward the entire team with a cash bonus if they could achieve 60% revenue growth over a certain period of time. Robinson said founders and top executives will receive additional equity in the form of stock options if they meet certain revenue targets.
“This allowed us to be very transparent about our company-wide goals and our executive team goals,” he said. “It reminded people that the core underlying business remains strong.”
The question on many venture capitalists’ minds now is what will happen when many AI companies raise capital at high valuations.
“I think it would be difficult to argue that valuations are not overly inflated in the current market,” Grayson said.
Basu Trivedi, who has invested in several AI startups, including AI detector GPTZero, said many AI companies “have the fundamentals that justify the hype and valuations,” but it’s still hard to say which AI companies will succeed in the future. He added that it is difficult. “Some of these categories are very competitive,” he said. “There are about 20 companies doing really similar work.”
