Down Rounds & Secondary Sales
Your Series B is at $50M valuation. Series C is at $30M. Your valuation went down. This changes everything for founders. Here's the math and your options.
Down rounds happen. Market cools, growth slows, competitors emerge. Your startup is still valuable, but investors aren't willing to pay the peak price anymore. This is humbling and it has real consequences.
The mechanics get complicated fast: anti-dilution provisions kick in, liquidation preferences affect who loses how much, and founders suddenly have options they didn't have before (like secondary sales). You need to understand the landscape.
The Reality
Down rounds are common (20-30% of Series B+ companies experience them). They're bad, but not fatal. Your path forward depends on: how much the valuation dropped, anti-dilution math, and whether you have a plan to turn things around.
What a Down Round Actually Means
The definition is simple: your Series C is raised at a lower valuation than your Series B. What this implies is more complex:
Signal 1: You Missed Growth Expectations
Your Series B investors expected you to grow 100%. You grew 30%. Now investors aren't paying 2021 multiples anymore. Fair or not, that's how pricing works.
Signal 2: Market Conditions Changed
Even great companies get hit in down markets (2022-2023). The whole category might be down 50%. Your down round is smaller but still exists.
Signal 3: Execution Risk is Higher
Investors have new data showing you're harder to acquire customers than expected or unit economics worse than modeled. Higher risk = lower valuation.
The point: investors are re-pricing based on new information. This affects your cap table in specific ways.
Anti-Dilution: When It Helps and Hurts You
Most investor term sheets include anti-dilution provisions. In a down round, these provisions have a mechanic effect on your ownership.
Broad-Based Anti-Dilution (Founder-Friendly)
If down round happens, previous investors' share price adjusts down to the new round price. Everyone dilutes together.
Example: Series B at $20/share. Series C at $10/share. Series B investors' shares convert to $10/share too. Ownership stays proportional.
Narrow-Based Anti-Dilution (Investor-Friendly)
Previous investors' share price adjusts down based on cap table math that excludes certain shares (employee options, etc.). More punitive to common (founders).
Example: Series B gets super-conversion rights, ending up with 3x their original shares. Founders dilute heavily.
Most Series B terms include broad-based anti-dilution. But if your Series B has narrow-based, a down round can hit founders hard.
Know Your Terms
Before you raise Series C, understand: what anti-dilution rights does Series B have? Is it broad-based (everyone dilutes equally) or narrow-based (founders get hit harder)? This determines the pain.
Down Round Math: A Real Example
Let's work through what happens to founder ownership in a down round:
Starting Position (Series B)
Down Round Happens: $60M valuation (40% down)
What changes: new Series C investor wants to buy $15M at $60M valuation (25% of company).
Everyone dilutes roughly equally (broad-based). But look at the founder impact: you went from $30M (30% of $100M) to $13.5M (22.5% of $60M). That's a 55% hit to your equity value.
Secondary Sales: Liquidity in a Down Round
Down rounds sometimes create an opportunity: secondary sales. New investors might want to buy directly from founders (not just invest new money).
What is a Secondary Sale?
You (founder) sell some of your equity to the new investor. They buy your shares directly (not new investment, just ownership transfer). This gives you liquidity without diluting the company further.
Why Would You Do This?
In a down round, your equity is worth less. But it's still worth something. If you can sell 10% of your shares to new investor at the new valuation, you get cash now (instead of waiting for exit in 7 years).
Downsides
You lose upside potential (the equity you sold could be worth 10x in 5 years). You also reduce your ownership % (might affect voting power or board seat).
But you get liquidity now to pay taxes, pay down personal debt, or just reduce your all-in-one-basket risk.
Secondary sales are common in down rounds. 20-40% of founders participate when given the option.
When to Consider Secondary
If you need liquidity, if you're underwater (underwater on your original investment), or if you want to diversify risk—consider it. But don't do it if you believe in the company's comeback. You're betting against yourself.
How Founders Should Respond to Down Rounds
Down rounds are painful. But there are right and wrong ways to respond:
Understand the Math First
Before you react, know: what's the new valuation? What's your ownership post-round? How much did you dilute due to anti-dilution? What's your new board seat situation?
Push Back on Terms (If Justified)
If valuation is too low relative to metrics, push back. You might be undervalued due to limited buyer competition. But don't fight for pride—fight for survival.
Decide on Secondary Participation
Evaluate: do you believe in the company's path forward? If yes, hold. If no, consider secondary. Be honest with yourself.
Communicate to Your Team
Down rounds are demoralizing. Be transparent: why did it happen? What's the plan to turn things around? How does this affect equity holders (employees)?
Focus on Execution
The market is telling you your business is worth less. Prove them wrong. Down rounds often lead to the best companies (constraints force discipline). Execute hard.
Facing a Down Round?
Eagle Rock CFO helps founders understand down round mechanics, model anti-dilution impact, and decide on secondary participation strategically.
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