Down rounds prevail as power shifts back to VCs

They look like things is not going well with startups these days.

Down rounds, or a funding round in which a startup raises capital at a lower valuation than its last investment, are more common than the venture community has seen in nearly half a decade. According to data from Carta, the number of downturns in the first quarter of 2023 nearly quadrupled compared to a year earlier.

Down rounds are bad because they can lead to excessive dilution, unhappy investors, employees worried about the value of their equity, and other less than attractive events. They are new to many startups and were quite rare during the most recent venture boom when so many startups raised several upwards rounds the same year it became a mini-trend.

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It’s not shocking to see downside rounds becoming more common, but it’s somewhat surprising that they accounted for nearly a fifth of all venture capital investment Carta saw in the first quarter. Things have gotten worse for startups much sooner than we expected.

Furthermore, Carta reports that a minimum of “40% of all investments in Series A and Series B companies were bridging rounds in Q1, the highest numbers of the 2020s.” The same forces that are driving the prevalence of down rounds are at play here: Namely, the pace and value of venture capital deals are closing, and as public markets have reset, so are valuations for startups at all stages.

Down rounds, flat rounds and more complex venture terms

When we went through Carta’s first take of the Q1 2023 data, we found that fewer dollars would work at lower prices.

That may sound like a strange combination of events. After all, if startups are cheaperwhy don’t venture investors more capital to work? It’s because venture investing is essentially a momentum trade, where rising prices for startup stocks allow investors to raise more capital, allowing them to put more money to work at even higher prices.

Yes, it’s something of a self-reinforcing cycle. If you press a VC during periods of exuberance about why they are moving so fast and nominally skipping important techniques of intelligent investing like due diligence, they will say something about the need to play the game on the field.

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