Issue 4: Cram Down
Hello to Our Readers
A "cram down" is a term that is often used to describe a down round financing in which existing investors lead a new financing that includes terms that may be severely dilutive to nonparticipating investors and that may include other features, such as forced conversions and "pay-to-play" mechanisms, that may have the perceived effect of punishing nonparticipating stockholders. In a severe cram down, existing stockholders who do not participate in the round may end up with little or no meaningful ownership stake in the company.
As desperate startups look for cash, some companies and their investors will need to accept cram downs.??
The 2020 downturn was over so quickly that there really was no time for cram downs.? The 2008 recession was before the recent explosion in syndication.? The new investment landscape is going to make cram downs especially fraught.
A fund or an individual investor can usually choose to invest more in a cram down and retain its ownership rights.? A syndicate cannot - it raises money once and then invests all of the money immediately.? A syndicator can create a new syndicate to invest in a cram down, but unless all of the earlier syndicate’s investors participate in exact proportion to their original investment, there is no obvious fair way to allocate the full benefits of the investment, including the “pay to play” benefits to the original syndicate’s holding.
We expect to see cram downs in which syndicators and other investors face off against each other.? Funds and angels can design terms that allocate most of the pain of a down round to investors who do not participate in a recapitalization.? This will allocate most of the pain to syndicates.? Syndicators will fight back and look for ways to block these terms, but very few syndicators have a way to pay to fight these deals.? When there are too many people on a sinking ship to fit in the life boats someone has to drown, and in today’s startup Titanic's no one is going to yell “Women and children first!”
Cram downs are coming.? Upsetting, infuriating, unfair, and soon the only option to save some good companies.
Don’t get Musked!
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A Last Word
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