Navigating a down round
Navigating a down round
So, you’ve got a down round…what next? Does the aftermath always have to be horrendous? And how do you keep people motivated when their share options nose-dive? Our panellists discussed how not all down rounds are created equal, how to communicate a down round to staff and investors, how to incentivise those within the company to continue to grow it, and how a down round can be turned into an opportunity.
Not all down rounds are created equal…
Sam Marsden, Investor at Kinnevik, said that there is a difference between a 10% down round, a situation where a company’s price goes down by 50%, largely a market-driven phenomenon that has been common in the past 18 months, and a business’ price being 90% -- or a “house on fire” situation, he says, where a company is facing operational issues.
“I think the down round is a big, scary umbrella term, but it's important to look under the hood and figure out what's going on: is the down round the result of a macro-economic driven issue or something that’s happening with the company -- they can often be the determinants of the down round, rather than its performance."
Sam Marsden, Investor, Kinnevik
… and taking stock after one
Peter Orlov, General Counsel at several VC funds, adds to this by noting that down rounds are not always “bad, bad news” and that it’s important to look at them in the context of a company’s business plan -- its growth, its projects. If the company is meeting its plan and the macro environment has pushed valuations down, investors will be a lot more comfortable than if the plan is “unravelling”. He says that, regardless of the situation, a down round can be a good time for a company’s founders and its investors to stop and think about the overall picture that the business finds itself in.
He adds that down rounds should not imply that a company’s trajectory will continue to be where it currently is and that some companies manage to trace a positive trajectory following a slump - noting examples such as Amazon in the early 2000s and Klarna following the Covid pandemic.
Andrew Secker, Partner at Mills & Reeve, agreed, saying that down rounds are a good moment to look at a company’s key strengths in terms of the people that work within it, who it needs to incentivize, and how it is going to do that to bring the company back on its feet. “If you’ve overemphasised the value of shares and share options that may be more difficult. But I think it's a really pivotal moment to be looking at your talent and your product line a bit more generally”.
Managing the communications, and incentivising staff following a down-round
Depending on what has caused a down round, this might be easier to communicate to employees, investors and senior managers. Sam says that it’s important for a company to “own the narrative”, especially because the high-growth space is a small market and investors tend to talk. He gave the example of the CEO of a US fintech, which repositioned the company’s down round as a positive, celebrating the fact that it managed to raise a couple of million dollars in a difficult market environment. Similarly, Peter advised that companies be openly communicative “as early as commercially practical”, since this can make the conversations easier.
When it comes to talking to staff, Andrew says that it is likely that some of them may have already known what was coming. They could work at a much larger company for a higher salary, but many people join some high-growth businesses because it aligns with either their passion or their values, and that has a really important part to play. Andrew adds that a down round can also be a good opportunity to restructure how staff are compensated and incentivised. “It starts with the company asking: what do we need to deliver to get our valuation back on track. But if it just goes back and redesigns its existing options, it misses the point of the down round”.
One piece of advice for an in-house counsel currently going through a down round?
Sharing his employment law expertise, Andrew advises in-housers to grab hold of the contracts of the “very, very key talent” and check that their contracts have all the right provisions to keep them within the business for as long as possible, followed by a sit down with founders and managers to work out what are the key areas of the business that must be upheld.
Peter notes that it is also equally important to re-evaluate a company’s cap table and structure, to plan strategically and prevent another down round in the future, while Sam focused on the point of communicating very clearly what has happened and what has caused the down round to employees, since the event can be an opportunity.