What is down round protection?

“Down-round protection” — a common feature in many instruments that limits the dilution to existing investors when an issuer sells new equity or equity-linked instruments for a lower price than it sold equity in a previous financing — can trigger significant accounting implications.

What is down round mean?

A “down round” is a financing in which a company sells shares of its capital stock at a price per share that is less than the price per share it sold shares for in an earlier financing.

How does a down round work?

A down round refers to a private company offering additional shares for sale at a lower price than had been sold for in the previous financing round. Simply put, more capital is needed and the company discovers that its valuation is lower than it was prior to the previous round of financing.

What is a down round clause?

Down-round protection and anti-dilution clause mechanism

When a private company raises additional capital by way of issue of shares of such a company at a price lower than the previous round of funding is referred to as down-round funding.

What is an up and down round?

What Is the Difference Between Up Rounds and Down Rounds of Financing? Both up rounds and down rounds are effective ways of raising capital, but the amount of capital raised differs. If the pre-money valuation increases, it is an up round, but if it actually decreases, it is a down round.

What Is A Down Round?

How do you avoid a down round?

The best way to avoid down rounds is to be prudent and strategic when raising funds. As Y Combinator points out, the temptation to raise as much money as you can is very strong for startups, particularly as large valuations and capital raises are celebrated as markers of success.

What is a down round startup?

A down round occurs when a private company raises additional funding at a lower valuation than it had during a previous round of funding. Typically, startups raise down rounds if their initial valuation was inflated or their burn rate exceeds expectations.

How does anti-dilution protection work?

Anti-dilution provisions act as a buffer to protect investors against their equity ownership positions becoming diluted or less valuable. This can happen when the percentage of an owner's stake in a company decreases because of an increase in the total number of shares outstanding.

What is full ratchet?

“Full ratchet” refers to a type of anti-dilution protection for preferred stock in the event of a down round of series financing that adjusts the number of common shares the preferred shares can be converted into based on the new share price.

What is a convertible note round?

A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round; in effect, the investor would be loaning money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company.

What are down round features?

A down round feature is a contractual term to protect the investor in an equity-linked instrument such as a warrant or convertible debt from declines in the issuer's share price under certain circumstances. It results in the strike price being reduced on the basis of the pricing of future equity offerings.

What comes after Series E funding?

Series C is often the last round that a company raises, although some do go on to raise Series D and even Series E round — or beyond. However, it's more common that a Series C round is the final push to prepare a company for its IPO or an acquisition.

What is weighted average anti dilution?

​Definition​ Weighted average anti-dilution is a form of anti-dilution that uses a relative (weighted) formula in a down round or other stock dilution to decrease the price at which preferred stock can convert into common stock.

How does post money valuation work?

Post-money valuation is a company's estimated worth after outside financing and/or capital injections are added to its balance sheet. Post-money valuation refers to the approximate market value given to a start-up after a round of financing from venture capitalists or angel investors have been completed.

What is convertible debt financing?

With convertible debt, a business borrows money from a lender where both parties enter the agreement with the intent (from the outset) to repay all (or part) of the loan by converting it into a certain number of its common shares at some point in the future.

What is pro rata right?

A pro rata right is a right that is given to an investor that allows them to maintain their initial level of ownership percentage during later financing rounds.

What is IPO ratchet?

Mutual funds have become significant investors in IPO financings, typically seeking two types of provisions: (1) redemption rights that allow them to escape (possibly if the IPO is delayed), and (2) a pricing “ratchet” that entitles them to additional shares in the event that the IPO prices below the valuation ...

What is a pay to play provision?

A "Pay to Play" provision is a requirement for an existing investor to participate in a subsequent investment round, especially a Down Round.

How do I protect my shares from being diluted?

Full Ratchet and Weighted Average Dilution Protection

Outlined in a company's funding and investment agreements, the most common form of anti-dilution provision protects convertible stock or other convertible securities in the company, by mandating adjustments to the conversion if more shares are offered.

Do you lose money when shares are diluted?

Dilution is the reduction in shareholders' equity positions due to the issuance or creation of new shares. Dilution also reduces a company's earnings per share (EPS), which can have a negative impact on share prices.

What are the two forms of anti-dilution protection?

What is reverse vesting?

Reverse vesting agreements give the company repurchase rights to those shares not yet mature for a nominal fee or in many cases, for no cost at all. By this agreement, other shareholders have the absolute ability to buy back any shares not yet vested from the founder if they leave.

What is a company cap table?

A capitalization table (or “cap table”) is a document, like a spreadsheet or table, that details who has ownership in a company. It lists all the securities or shares in a company including stock, convertible notes, warrants, and equity grants.

What happens to options in a down round?

Given that virtually all options are struck with an exercise price at least equal to the per share fair market value of the company at the time of grant, as soon as a down round occurs, employees' previously granted options will be underwater and will remain underwater until the company obtains a new valuation that is ...

What is pre and post money valuation?

Key Takeaways. Pre-money and post-money differ in the timing of valuation. Pre-money valuation refers to the value of a company not including external funding or the latest round of funding. Post-money valuation includes outside financing or the latest capital injection.