A Guide to Up Rounds, Flat Rounds, and Down Rounds
The tech world is presently rife with analyses on the perceived valuations crunch in 2016, and in particular, a few examples of startup giants that apparently aren’t immune to it after all. But what does that mean for early-stage entrepreneurs that are just getting out of their seed and Series A rounds and onto the next stage? When it comes to up rounds, flat rounds, and down rounds, there are a few ways to predict where you’ll land so you can take action.
As an entrepreneur, you’re always striving for an up round. You want your valuation to increase with each round; it indicates your company has increased in value and puts you in a better position for negotiations in future rounds. The trick is figuring out what you need to actually earn that up round because as the market tightens up, it becomes harder and harder to get those higher valuations.
Perhaps the biggest determinant in a higher next round valuation is the company’s growth rate. Investors are typically looking for triple-digit growth year-over-year across key metrics like usage and revenue. They also consider how much capital it took to get to that growth rate over the period of time the company spent it. More specifically, less capital over a shorter amount of time with a high amount of growth is golden. You don’t necessarily have to check all of those boxes, but you do have to make a case for future success based on past experience.
To break it down even further, these are some of the key questions we ask when we’re looking at contributing the next round of capital:
· What is the company’s growth rate?
· How fast did it grow since the last raise?
· How much capital has it taken to get the company from one milestone to another?
· Has the company met or exceeded the milestones it identified in the last raise?
Ultimately, the size and status of your raise is going to be largely set by the answers to the above questions, but also the way you position your company, your existing relationships with investors, and what the market looks like.
With a flat round, you’re raising capital at the same valuation as your previous round. Flat rounds aren’t necessarily good news or bad news; a lot of the time, they come down to runway. For example, you may be tracking towards success or on your way to hitting a milestone, but you underestimated the capital you needed to continue along that path and need another injection before you hit 12–24 months.
Of course, flat rounds are also often used as a last stand against a down round. Depending on the investment philosophy your investors subscribe to, not raising at a higher valuation implies a failure to drive growth and ultimately suggests you’re not meeting your targets. However, raising a down round can be damaging on multiple levels, but especially in terms of the next raise. Investors will sometimes agree to flat terms if they believe in the company and know that a down round will negatively impact them in the future.
As an entrepreneur, it’s important to remember that while a flat round can feel more neutral than a down round, it will still dilute your equity in your company.
When you’re trying to predict where your company will realistically land during your next raise, ask yourself a few key questions to determine if there’s a likelihood you’ll have a flat round:
· Am I “in between” in my growth rate? Specifically, is my growth rate slow and stable or somewhat static, but not in danger of plummeting?
· Do I need capital before 12–24 months for reasons other than explosive growth?
· Do I have investors who are willing to bridge me from the effects of a down round?
There are a few reasons you might have to raise your next round at a lower valuation than your last, with the two most cited including that your last valuation was unrealistically high and put you in a difficult situation, or that your business is in trouble. Both situations are bad, especially because chances are you’re going to be pegged as the latter no matter what.
Still, even though a down round can often be the death knell of your startup, it doesn’t have to be. The chart below looks at a few high-profile down rounds since 2009.
Some of these companies bounced back and others are currently in dire straits. Their futures came down to a number of factors, including why they needed to raise the down round in the first place, what they did to address the problems they were facing, and what their market shaped up to be.
While these examples of high-profile down rounds may seem extreme, they prove that a company at any stage can face a down round, and that there are many potential outcomes. If your startup is seeing growth fizzle and failing to gain the traction it needs to justify a flat or higher valuation, you need to evaluate it from an operations perspective. Optimism aside: can you turn things around? What’s more, is there a way to do it without outside institutional capital? Or, will that institutional capital solve the problem, rather than just keep the lights on a bit longer until you finally have to close down? Making the right decision for your startup based on facts and a clear strain of logic is critical to surviving a down round and continuing on the path to success.
This post is part of the Hyde Park Angels Entrepreneurial Education Series, which brings together successful, influential entrepreneurs and investors to teach entrepreneurs everything they need to know about early-stage investment through events, articles, videos, and more. If you are interested in learning more about similar topics, register for “When to Raise Venture Capital or Bootstrap” on March 3.
About Hyde Park Angels
Hyde Park Angels is transforming early-stage investing by taking a people first approach. The organization is the largest and most active angel group in the Midwest. With a membership of over 100 successful entrepreneurs, executives, and venture capitalists, the group provides critical strategic expertise to entrepreneurs and the entrepreneurial community. Nearly 40% of our members have founded a company, 88% are CEO’s, top executives or corporate board members, and 100% invest in startups. By leveraging the members’ deep and broad knowledge of multiple industries and financial capital, Hyde Park Angels has driven multiple exits and invested millions of dollars in over 40 portfolio companies that have created over hundreds of jobs in the Midwest since 2006.
About the Author
Alida Miranda-Wolff heads up communications and strategy at Hyde Park Angels, crafting and disseminating the organization’s brand in all forms across all channels. In addition to single-handedly building HPA’s integrated communications plan and executing its core elements, Alida manages membership, partnerships, portfolio company support, and all community engagement.
Prior to joining Hyde Park Angels, Alida served in a variety of journalism, marketing, communications, and management roles, specializing in creating spreadable multimedia content for tech-enabled businesses at all stages. Alida has run several Kickstarter campaigns, including one of the most successful in Chicago history, and still mentors companies running their own campaigns.
Alida graduated Phi Beta Kappa from the University of Chicago in 2014 with multiple honors and awards. She remains active in the university of alumni network, serving on five advisory boards and committees. Alida is also a published author and poet, with two poetry chapbooks currently in print, Domestic Scenes and Tree Fingers.