Preparing for the Dreaded Down Round

Venture capitalists (VCs), like crypto retail traders, essentially invest based on gut instinct.

Sometimes this process is called “momentum,” as in a growing company or an appreciating coin is sure to do well if it has been doing well. Sometimes VCs or traders might establish standards and check to see if they’re met before investing in a project. In venture capital, this might be called “due diligence;” in crypto, it’s doing your own research.

Investing clearly has a psychological component. And few things are worse for individual companies or broad-based market sentiment than when startups start raising “down rounds.”

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“In Silicon Valley venture financing, a ‘down round’ is to be avoided at all costs,” the Wall Street Journal has boldly proclaimed. “Startups worry that the damage of down round is far-reaching for recruiting efforts, existing employee morale, customers and partners.”

Down rounds are when a company raises capital at a lower valuation. It means that the stock price paid in previous investing rounds has declined.

Yesterday, Frank Chaparro at The Block reported that crypto lender BlockFi is set to raise an undisclosed amount of money at a $1 billion valuation, down from its previous round when it was valued at $3 billion.

This is the largest profile down round to have occurred since the beginning of the crypto market’s downcycle. It speaks to the bearish mood, imminent monetary tightening and a likely pull back in venture capital financing that has acted as an accelerant for token markets.

Chaparro called it “a striking development” considering the “high degree of venture capital activity only months before.”

In BlockFi’s case, it might also speak to the regulatory uncertainty around its core business after paying a $100 million penalty to several securities regulators regarding a high-yield lending product.

Yet, BlockFi is still a unicorn, or a private company with a $1 billion valuation. At the beginning of the year, there were more than 900 such companies – a smattering of them in crypto – compared to 80 total in 2015, according to CBInsights.

It seems likely that further down rounds in crypto will follow, if only because people keep thinking about it. The perception of momentum affects both startups and markets. At a startup, a down round could be demoralizing for employees as it might feel like a step backwards.

See also: Are Exchange Layoffs the First Sign of Crypto Winter, or Is It Already Over? | Opinion

It might also signal to outside investors that a business’ outlook isn’t great – that it could even shut down. Measuring this is difficult, as private companies are under no obligation to share financial data publicly.

In markets, a bearish mood could make it harder for newer startups to get funded. Then again, because crypto startups can literally print money, the mechanisms are a little different.

Periods of down rounds are not rare and appear cyclically. The last period where more companies were raising down than up occurred at the beginning of the coronavirus pandemic. But TechCrunch also covered the phenomenon as a trend in 2015 and 2018. An optimist would see these as momentary checks on irrational exuberance.

Stay afloat

If CoinDesk wrote about traditional tech markets, this might be the point where we offer sage advice to “smart founders” looking to mitigate downturns. We might talk about checking to see how much runway you need to get to profitability and raising that amount if you don’t have it on hand – even with the stigma of a down round. (But check your “anti-dilution” clauses first!)

We might also talk about being realistic: When markets are exuberant, and its investors are practically throwing money away, you can raise money on pretty favorable terms. Now, you might expect to give up a board seat or to hear more about strategy and direction from investors. If you have to listen to a veteran investor to stay afloat, you must.

See also: How to Make Money From the Crypto Backlash | Opinion

We might say something like, “flat rounds are the new up round.” Or “the best thing would be to have raised yesterday.” Or list the multi-billion dollar public companies that previously “lost momentum” by taking a down round.

It’s not that down rounds do not matter in crypto or that its investors are any less psychological. But the idea of a firm is entirely different if you want to build actually decentralized businesses and protocols. So my only advice is, maybe you shouldn’t take venture financing in the first place.