Public market valuations for tech companies are down significantly from where they were at the heights of 2021. Given the pullback in public market valuations, we have not seen as many down rounds in the private markets as one might expect. There may be a massive wave of down rounds that have been done quietly, but I do not believe that’s the case.
The prevailing narrative is that down rounds aren’t happening because founders and their investors are unwilling to accept the pain of lower valuations. I think this is part of the equation but not the whole answer. I believe there is another reason we are seeing fewer down rounds than one might expect.
Getting a down round requires two things. You need a company willing to raise money at a lower valuation and a new or existing investor willing to invest in the company. In my experience, the current lack of bidders on down rounds is a bigger issue than the unwillingness of companies to sell at lower prices.
Down rounds are often complicated and hard. In addition to accepting the reality of a lower valuation, there’s a lot of coordination that has to happen between the company’s management, existing investors, and new investors to get to a place where the post-financing cap table makes sense. In most cases, doing a down round is more work and time than simply investing in a company where the valuation is flat or up. Some companies use SAFEs with valuation caps lower than the last round’s valuation to finesse this point, but that bill will come due when the company raises its next priced equity round.
Opportunities to invest in down rounds don’t exist in a vacuum. Down rounds compete with the opportunity to invest in other companies at a similar stage and profile that don’t need down rounds. Given the work required to pull off a down round, I think many investors are voting with their wallets and choosing to invest in companies that don’t require the work associated with down rounds.
Not every company that does a down round is damaged goods or fundamentally flawed. I think there are good companies in the market where the valuation got beyond what makes sense in the new environment, and a reset is needed. But it feels to me like getting investors interested in and excited about doing the work to make these down rounds happen is significant, and volumes will remain low until the calculus changes.