Startup creators wish for their enterprises to consistently secure larger investment rounds with increasing valuations. Yet, unforeseen obstacles, such as a worldwide health crisis or a rapid increase in interest rates, can greatly affect a business’s capacity to sustain its valuations.

Certain startups might need to turn to down rounds, which involve new financing at a valuation lower than the company’s earlier one. Although founders and investors generally make significant efforts to avoid down rounds, contrary to prevalent assumptions, these transactions don’t inherently have a catastrophic effect on a startup’s trajectory.

“Our initial investment, upon establishing our firm in 2021, was a down round recap of a company that underwent a complete shift during COVID,” Nikhil Basu Trivedi, a co-founder of Footwork, shared onstage at TechCrunch Disrupt 2024. “Their original enterprise was in the college housing niche, which was utterly disrupted as soon as the pandemic struck.”

Footwork restructured the company’s cap table and established a new stock option pool for the whole team, noted Basu Trivedi, further stating that the company’s new venture, a subscription platform for dining establishments referred to as Table22, “managed to endure and prosper from that endeavor.” Table22 announced an $11 million Series A led by Lightspeed Venture Partners last week.

Nevertheless, not all companies that undertake a down round experience a total revival. Elliott Robinson, a partner at Bessemer Venture Partners, highlighted onstage that if a business is in trouble, “there’s a substantial chance someone else in your domain or a rival is facing many of the identical obstacles.”

Robinson urged startups in such positions to remain steadfast. “If you’ve gone through a down round, that’s acceptable,” he remarked. “In a difficult market environment, that might actually be advantageous. It may not become evident until several quarters out, but often the market may present new opportunities if you choose to persist.”

Well-known companies that experienced valuation reductions include Ramp, previously valued at $5.8 billion last year, a 28% reduction from its prior $8.1 billion valuation. The fintech regained some of its value this April when Khosla Ventures valued it at $7.65 billion.

Down rounds were infrequent during the pandemic-era surge, nonetheless, their occurrence as a share of all deals has more than doubled from 7.6% in 2021 to 15.7% in the initial half of 2024, as per PitchBook data.

Startup valuations significantly decreased after the U.S. Federal Reserve enhanced interest rates, and numerous companies remain overvalued in comparison to their performance, relayed Dayna Grayson, co-founder at Construct Capital. Some of these entities might be contemplating down rounds, yet for many founders, these deals are intensely stressful.

In the case of a down round, both employees and founders end up holding a reduced ownership share of the company.

“I believe the most daunting aspect for numerous founders is managing employee morale,” Grayson said. “Nevertheless, you can indeed motivate individuals through down rounds.”

Robinson, who aided three portfolio companies through either flat or down rounds in the past eighteen months, elaborated on how investors motivated the workforce and leadership of one such company to stay dedicated following a down round. He illuminated that while everyone at the enterprise saw a reduction in valuation, investors set up a bonus pool targeting a cash reward for the entire team if they could attain a 60% revenue rise over a defined period. Robinson mentioned that founders and senior executives would also gain supplementary equity via stock options if they met particular revenue milestones.

“That enabled us to make the company-wide and executive objectives highly clear,” he mentioned, adding it “reaffirmed to the team that the core foundational business remains robust.”

Presently, a major question for numerous venture capitalists is predicting what will happen with numerous AI companies garnering capital at significant valuations.

“I believe it would be challenging to refute the presence of overblown valuations in the market now,” Grayson stated.

Basu Trivedi, who placed investments in numerous AI startups, including AI detector GPTZero, expressed that several AI “companies possess the frameworks to substantiate the anticipation and valuations,” but also admitted it still remains difficult to ascertain which AI companies will flourish. “Some of these segments are intensely competitive,” he expressed. “There are roughly 20 entities doing incredibly similar activities.”