Down Round
What is a down round?
A down round occurs when a startup raises new equity capital at a valuation lower than its last round. A company that raised Series A at a $30M post-money and raises Series B at a $20M pre-money is raising a down round. Down rounds trigger anti-dilution provisions in existing preferred share agreements and carry significant signalling risk.
Which anti-dilution mechanisms are triggered by a down round?
| Mechanism | How it works |
|---|---|
| Full ratchet | Investor conversion price resets entirely to the new lower price. Most punishing for founders and new investors. |
| Broad-based weighted average | Conversion price adjusts proportionally to the size of the down round vs total shares. Market standard. |
| Narrow-based weighted average | Same formula but uses a narrower share count. Slightly more favourable to existing investors. |
Broad-based weighted average anti-dilution is the market standard per the NVCA model legal documents. Full ratchet provisions are rare in early rounds but occasionally appear in distressed bridge financings.
What causes a down round?
The three most common causes: a previous round priced at an inflated valuation during a market peak, revenue or growth that did not meet the trajectory implied by that valuation, and broader market multiple compression that affects comparable company pricing. Down rounds are more common following public market corrections that reprice private growth assets.
What is the economic impact of a down round on common shareholders?
In a down round, existing preferred shareholders with anti-dilution protections receive additional shares at no cost to compensate for the lower price per share. These additional shares come from the existing fully diluted share count, diluting everyone who does not have anti-dilution protection: founders, employees holding options, and any preferred shareholders who waived anti-dilution. A typical broad-based weighted average anti-dilution adjustment might add 5 to 15 percent to an investor's share count, with all of that dilution falling on unprotected common holders. The practical effect is that a down round shrinks founder ownership twice: once from the new shares issued to raise capital, and again from the anti-dilution adjustment shares issued to existing investors.
How should founders communicate a down round to employees?
Employee option holders are directly affected by a down round in two ways. First, their options may become underwater (strike price above the new 409A fair market value), which triggers a required 409A refresh and may cause employees to feel their equity is worthless. Second, the anti-dilution adjustment shares issued to investors further dilute employees' common ownership. Founders should communicate the down round clearly, explain that the company's trajectory matters more than the current valuation, and consider requesting a repricing of employee options at the new lower strike price. Option repricing requires board approval and is subject to specific tax rules under IRS Section 409A.
What do founders get wrong with down rounds?
The most common mistake is delaying the decision to take a down round for too long. Founders who spend 6 to 12 months trying to avoid a down round by cutting costs and extending runway often arrive at the same down round from a weaker position: lower ARR growth, higher churn, depleted team morale, and diminished investor confidence. A down round taken early with strong co-investors and a clear plan is far better than one taken from desperation. The valuation reset is painful but recoverable. Running out of money before accepting the reset is not.
A second error is not negotiating the terms alongside the valuation. A down round is an opportunity to clean up the cap table: pay-to-play provisions can convert non-participating investors to common, reducing the preference overhang. Removing investors who are not adding value and will not follow on makes the cap table healthier for subsequent rounds. Founders who accept the down round price without negotiating these structural improvements miss a one-time opportunity to reset the cap table dynamics.
Third: not modelling the anti-dilution adjustment before agreeing to the down round price. Broad-based weighted average anti-dilution is a formula, not a fixed dilution amount. The adjustment depends on the ratio of the old and new conversion prices and the number of new shares issued. Founders should calculate the exact anti-dilution adjustment at the proposed new price before agreeing to terms, so they understand the total dilution impact rather than just the headline new ownership percentage.
How it works in practice
Case example: Series B down round, SaaS infrastructure company
A cloud infrastructure SaaS raised Series A at a $40M post-money in 2022 at 20x ARR ($2M ARR). By 2024, ARR grew to $3.5M but market multiples compressed to 8x. The company needed $5M to reach profitability. The Series B was priced at a $28M pre-money, a $12M step down from the Series A post-money.
The Series A investor held broad-based weighted average anti-dilution. Their conversion price adjusted from $2.50/share (Series A price) to $2.18/share. This gave them approximately 12% more common shares on conversion, not full ratchet, but meaningful protection.
The CEO communicated the down round proactively to the team before close, framed it as securing a path to profitability rather than a distressed event. A 15% option pool refresh at the new lower strike price helped retain key engineering and product staff whose previous options were now underwater.
Frequently asked questions
Can a startup recover from a down round?
Yes. Down rounds are stigmatised but survivable. Many successful companies have raised down rounds and subsequently grown to strong exits. The key is addressing the underlying performance issue the down round reflects, managing employee morale through transparent communication, and ensuring the new capital actually solves the problem.
Do employees lose their options in a down round?
Options are not cancelled, but their strike price may be above the new share price, making them temporarily underwater, meaning the current value per share is below the exercise price. Boards sometimes reprice existing grants or issue new grants post-down round at the new lower FMV to retain key staff.
Is a flat round the same as a down round?
No. A flat round prices the new shares at the same valuation as the previous round. This is less damaging than a down round but still signals that growth has not met expectations. Anti-dilution provisions are not triggered by a flat round.
Does a down round affect the 409A valuation?
Yes. A new funding round is a material event that requires a 409A refresh. After a down round, the 409A fair market value of common shares will typically decline, reflecting both the lower preferred share price and the increased liquidation preference overhang.
Does a down round affect employee option strike prices?
Indirectly. A down round triggers a new 409A valuation, which establishes a new (lower) fair market value for common stock. New option grants after the down round will have a lower strike price, which is beneficial for new employees. Existing out-of-the-money options (granted before the down round at a higher strike price) remain at their original strike price unless the board approves a repricing, which is a separate board action subject to its own tax rules.
Related glossary terms
- Anti-Dilution, the mechanism that adjusts investor conversion prices when a down round occurs
- Pre-Money Valuation, the valuation figure that determines whether a new round is a down round
- Waterfall Analysis, models how the preference stack changes after a down round increases liquidation overhang
Explore related Fintera content
- How to Prepare Financials for a Series A Raise, what investors check before pricing a round, the same metrics that determine whether a down round is likely
- Fractional CFO for Startups: The 2026 Playbook, how a fractional CFO models valuation scenarios and manages the financial narrative around a raise
Navigating a difficult fundraise or valuation reset?
See how Fintera models the scenarios and manages the narrative around a down round.
See how Fintera works