Key Takeaways
- A down round is a priced round where the new price per share is lower than the price paid in the previous round; a lower headline valuation alone does not make it one
- Anti-dilution protection in the earlier preferred stock lowers that series' conversion price, so earlier investors receive more common shares on conversion and founders absorb extra dilution
- The NVCA model charter uses broad-based weighted average anti-dilution as the standard; full ratchet is rare and far more punitive
- A down round usually needs a charter amendment, which under Delaware law requires board approval, a stockholder vote and often a separate class vote of the affected preferred
- A priced round is a material event for the 409A, so a down round typically resets the common stock price and can leave existing options underwater
- Structured rounds (flat price, senior or multiple liquidation preference) avoid a lower headline price but often cost founders more at exit
- The cheapest way to avoid a down round is to raise with 18-24 months of runway and test a smaller flat round, insider bridge or venture debt before accepting a lower price
A down round is a priced equity financing in which new investors pay a lower price per share than investors paid in the company's previous priced round. It dilutes existing holders more than a normal round, usually triggers anti-dilution adjustments in earlier preferred stock, and requires board and stockholder approval. It is survivable, but it reprices everyone's ownership.
This guide is general information, not legal or tax advice. Down rounds are financings where your lawyer and board earn their fees.
What exactly counts as a down round?
The test is price per share, not headline valuation: if the new round's price per share is below the prior round's original issue price, it is a down round. Founders often use the shortcut "pre-money below the last post-money," which is usually right, but option pool top-ups and SAFE conversions can move the headline valuation without changing the comparison that matters.
Three nearby terms get confused:
Down rounds are tracked as a share of all priced deals in the quarterly PitchBook-NVCA Venture Monitor, and Crunchbase News reports them as they happen. They rise when markets reprice after a period of high valuations, which is why a company priced at the top of a cycle is the most exposed when it next raises.
Why do down rounds happen?
A down round happens when the company's progress has not caught up with the valuation it last raised at, and no investor will pay the old price. The cause is almost always one of four things:
Only the third cause is fully in the founder's control. Runway is leverage. A company raising with 18 months of cash can walk away from a bad price; a company with 4 months cannot.
How does anti-dilution change the cap table in a down round?
Anti-dilution provisions lower the conversion price of earlier preferred stock, so those investors convert into more common shares and the founders and employees absorb the extra dilution. Preferred stock converts into common at a ratio of original issue price divided by conversion price. When a down round lowers the conversion price, that ratio rises.
The NVCA model legal documents, the templates most US venture deals start from, set out the main formulas in the model certificate of incorporation:
An illustrative example, not a real company: Series A investors paid $2.00 per share for 2 million shares. The company raises a Series B at $1.50. Under full ratchet, the Series A conversion price drops to $1.50 and those investors convert into roughly 2.67 million common shares instead of 2 million. Under broad-based weighted average, the adjustment depends on the size of the B round and lands somewhere between $1.50 and $2.00, usually much closer to $2.00 when the new round is small relative to the company.
Every extra share issued to an earlier investor comes out of the common holders' percentage. That is why the anti-dilution clause you signed two rounds ago matters more in a down round than the new term sheet.
What happens to SAFEs and convertible notes in a down round?
Unconverted SAFEs and notes convert at the new round's price, less any discount, when that price is below their cap, so the cap stops protecting the holder. Under the Y Combinator post-money SAFE, the holder converts at the lower of the valuation cap price and the discount price. When a priced round comes in below the cap, the cap does no work and the SAFE converts at the round price or the discount price.
Two consequences:
Model the conversion before you sign a term sheet. Founders are regularly surprised by how much ownership SAFE conversions take in a round of any kind.
What approvals does a down round need?
A down round almost always needs a charter amendment, which under Delaware law requires a board resolution, a stockholder vote and often a separate vote of the affected class of preferred. Creating a new series of preferred, increasing authorized shares or changing rights all run through Section 242 of the Delaware General Corporation Law. Section 242(b)(2) gives a class a separate vote when an amendment would adversely alter its powers, preferences or special rights.
On top of the statute, the existing charter usually contains protective provisions: the preferred holders, voting as a group, must consent before the company creates senior stock or changes their rights. Most companies collect these approvals by written consent under Section 228 rather than a meeting.
The fiduciary point founders miss: when existing insiders lead a down round, directors are approving a deal in which some of them, or the funds they represent, are on both sides. Delaware courts have reviewed insider-led recapitalizations under the demanding entire fairness standard. Standard protections:
What does a down round do to employee options and the 409A?
A priced round is a material event for the 409A valuation, so a down round usually lowers the fair market value of common stock and can leave earlier option grants underwater. Options must be granted at or above fair market value to stay clear of Section 409A of the Internal Revenue Code, and the Treasury regulations treat an independent appraisal as reliable for no more than 12 months and only if it reflects material information. A new, lower-priced round is material.
That creates two decisions for the board:
Equity is often the main retention tool in a company that just took a lower price. Fixing underwater options is usually the highest-return item on the post-round list.
How do you avoid a down round?
The most reliable way to avoid a down round is to start raising with 18-24 months of runway and to test every alternative to a lower price before accepting one. Compare the options on what they cost you at exit, not on how they look in a press release:
The general rule from experienced operators: a clean down round is frequently better for founders than a structured round at the old price, because the structure keeps costing you at exit while the lower price is paid once.
How do you run a down round without losing the team?
Run it fast, explain it plainly, and fix employee equity in the same board cycle. A down round that drags for months leaks to the team and to customers. A short process with a clear message limits the damage.
Before agreeing a price, benchmark what the company is worth today. Use comparable rounds and your current metrics, not the number from the last raise.
Frequently Asked Questions
What is a down round in simple terms?
A down round is a funding round where new investors pay less per share than investors paid in the company's previous round. It means the company is being valued lower than before. Existing shareholders are diluted more than in a normal round, and earlier preferred investors may receive extra shares through anti-dilution protection.
Is a down round bad for founders?
A down round dilutes founders more than a normal round and sends a negative signal, but it is not fatal. Many companies raise a down round, reset expectations and go on to grow. The bigger risks are running out of cash while avoiding one, or accepting structured terms that cost more at exit than a clean lower price would have.
How does anti-dilution work in a down round?
Anti-dilution provisions lower the conversion price of earlier preferred stock when new shares are sold at a lower price. Earlier investors then convert into more common shares, which dilutes founders and employees. Broad-based weighted average anti-dilution, the market standard, makes a modest adjustment; full ratchet resets the price all the way down to the new round's price.
What is the difference between a down round and a flat round?
In a down round, the new price per share is lower than the previous round's price. In a flat round, the price per share is the same. A flat round does not trigger price-based anti-dilution adjustments, while a down round usually does, so flat rounds are cheaper for common holders even though both signal slower progress than planned.
Do employee stock options lose value in a down round?
Usually yes. A down round typically lowers the 409A fair market value of common stock, so options granted at a higher strike price can end up underwater. Many companies respond by repricing or exchanging those options, which generally needs board approval and creates an accounting charge.
How can a startup avoid a down round?
Start fundraising with 18 to 24 months of runway, so you can walk away from a bad price. Before accepting a lower valuation, test cutting burn, an insider bridge, venture debt or a smaller flat round. Compare each option on what it costs at exit, not on how the headline valuation looks.