Dealing With Down Rounds

There is no way to sugarcoat it—the Asian startup funding is down in the dumps.

As per Crunchbase, Q2 2024 was the worst quarter for venture funding in Asia since the fourth quarter of 2015. Asia-based startups raised only US$14.6 billion in the second quarter of 2024, down 24% over last quarter and 32% year-on-year.?

With economic uncertainty becoming a new normal, venture capitalists have gotten used to operating with one hand tied behind their backs.?

Although the growing interest in AI is attracting large checks from investors, most of these checks are going to the North American and European markets where charismatic large language model players are thriving. And that’s the reason for the global startup funding to slightly jump in the second quarter of the year—reaching US$79 billion, up 16% quarter over quarter and 12% year-on-year.?

Asia is still behind, barring China, where powerful local companies (read Tencent, Bytedance, Alibaba, Moonshot, Baichuan AI, etc.)?have jumped into the fray with wild ambitions to dominate the AI world. But China has its own set of problems (domestic economy slump, regulatory environment, etc.) that have choked the funding flow a bit.?

In short, the money flowing into the regional startups has shrunk considerably. The check sizes are also considerably smaller compared to the last few years. This has led to two things:

• Investors are writing more early-stage checks.
• Investors are writing smaller checks for bigger rounds, except for those hot AI startups working on large language models.

With valuations regaining some sanity in 2023 and 2024, down rounds have become as common as cold. Startups are raising money, at lower valuations, lower than what they would have liked. For example, Indian hospitality star Oyo just raised money at a 75% lower valuation.?

While it might seem to some that the sky is falling, down rounds are just a bump in the road for those who are in for a long haul. It’s that bump that reminds you to adjust your pace and tweak your growth strategy for the journey ahead.?

Very often, founders take refuge in words of wisdom from those who have gone through a similar path. It’s also a way to learn what to do and what to avoid. We have summarised the best advice from global VCs, investment banks working with startups to raise capital and consulting firms that can help startups navigate down rounds.??

Avoiding Down Rounds

When it comes to a down round—the best thing is to avoid it, for as long as possible. To avoid getting in a situation where you have to necessarily go for a down round, you need to prep in advance:

• Extend the runway by increasing revenue or cutting costs

If the company is facing a down round, it may need to take steps to extend its runway. This could involve increasing revenue by adding new offerings, cutting costs and burns, or both.?

• Lean on existing investors

Raise bridge financing from existing investors to buy more time until a higher valuation round is possible. This necessitates picking up good investors early on. Those who have a good record of supporting their portfolios and are a good fit for your company to ensure you have the support when you need it the most.?

• Explore alternative forms of capital like venture debt?

Explore alternative financing sources like venture debt or revenue-based financing that can provide capital without the downsides of equity dilution, which in turn will help in maintaining valuation and ownership control. As a startup, this can extend your cash runway and allow you to achieve the necessary milestones before pursuing your next equity round at better valuations. You can also consider strategic partnerships or acquisitions that can provide additional funding or access to new markets.

• Have a tight funding strategy

Startups should plan their funding strategies carefully. Raise sufficient capital to meet growth targets without needing to resort to down rounds. At the same time, avoid raising too much capital too soon, as it doesn't leave enough time to hit growth milestones for a strong subsequent round.?

• Keep investors in the loop on your growth plan

Make sure the company has a clear and realistic plan for how it will achieve its goals. This will reassure investors that the company is on the right track. Keep investors updated on the company's progress and any challenges it is facing. This will help to build trust and confidence. So if need be, your investors might be more likely to support the company in a down round.?

Navigating Down Rounds

If you end up being out of the runway and you need to raise a down round, here are things to do immediately.?

• Deal with anti-dilution adjustment clauses?

When a company raises additional funding at a lower valuation, it is bad news for existing backers as their shares effectively become less valuable. To counter that, most investors have anti-dilution adjustment clauses in investment agreements that mandate the issuance of additional shares to them as compensation for the dip in the value of their existing shares. This, however, further dilutes the ownership of founders and other shareholders.?

The first thing is to negotiate with your existing backers to reduce the impact of anti-dilution adjustments. Try to convince them to either waive off or reduce the additional shares that are required to be issued by showcasing your company's promising prospects.?

• Communicate with investors and employees

After a down round, it is important to communicate with investors and employees to explain what happened, its potential impact on equity and what the company is going to do next. This will help rebuild trust and confidence. Be upfront about the reasons for the down round, whether it is missed milestones, market shifts, or overly optimistic previous valuations.

• Maintain employee morale and retain talent

Keeping the team motivated is critical for navigating the challenges following a down-round. Emphasise the company's long-term vision and growth potential to maintain employee motivation. Implement retention strategies, such as offering additional equity grants or bonuses, to keep key talent engaged.?

• Build a strong contingency plan, with eyes on profitability

Create a contingency plan that focuses on generating revenue to extend the runway until market conditions improve. Prioritise achieving milestones and improving financial performance. If you can improve cash flow and achieve profitability at some level to stabilise operations, you can build trust and regain investor confidence. As long as you optimise unit economics and pave the way for profitability, you can position the company for future growth and higher valuations.

• Maintain a Long-Term Perspective

Down rounds are a common occurrence in the startup ecosystem and do not necessarily reflect the company's long-term potential. Recognising that is important to keep yourself going. Build a strong foundation for growth by investing in product development, customer acquisition, and talent. Prepare in a way that you are in a better position in the industry when the market eventually recovers.

Living With Down Rounds: Is A Down Round Always Bad??

It takes courage to raise capital at a lower valuation to ensure sufficient runway for growth. After all, the confidence of your backers, the trust of your employees and your company’s reputation—all of that is at stake.?

But a down round is not necessarily bad. It’s a strategic retreat that can help you survive and thrive in challenging situations.?

Although down rounds have negative consequences, such as dilution of ownership for existing shareholders, it is definitely an opportunity for founders to get their metrics and path to profitability in order.?

In fact, some investors believe that a periodic market downturn is healthy because it forces companies to become more efficient. When they become efficient, they bounce back.?

Having raised a down round, you can rebound by:

• Rebuilding business strategy to focus on growth, utilising the fresh money
• Improving your product or service
• Building a strong team
• Improving execution?
• Resetting valuation to reflect market conditions, which can then attract new investors?

A down round is a chance for founders to reset expectations (your own and others’), build resilience and demonstrate adaptability, strategic thinking and leadership. With transparency, focus on profitability and long-term vision, startups can minimise its impact and emerge stronger from the experience.

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