‘Tidal Wave’ of Down Rounds Hits Startups

“We’re about to see a tidal wave of these companies doing reset rounds,” said Greg Smithies, a San Francisco Bay Area–based partner at Fifth Wall, an investor in Turntide Technologies and other climate and property tech startups. “It’s just going to get worse before it gets better.”

More executives are overcoming the stigma of such fundraises as cash needs loom. These types of deals also have consequences for staff, particularly for former employees, who will only have overpriced stock options that become nearly worthless. And such deals can be emotionally brutal. For Turntide, the fundraising has involved “250 investor conversations telling them they have to take big paper markdowns,” said Ryan Morris, the company’s CEO. But that beats running out of cash entirely. “The most important thing is recognizing reality,” Morris said.

In some cases, investors have to put new cash into companies that are at least somewhat distressed to avoid a total wipeout of their stakes, in pay-to-play deals. At farming startup Indigo Ag, last valued at close to $4 billion, investors recently learned that the startup was planning to sell new shares at a 96% discount from its round last year, two people familiar with the matter said. If they refrained from investing, they would lose additional ownership rights that come with preferred stock, one person said. An Indigo spokesperson declined to comment.

Other Silicon Valley private tech stalwarts could be making similar moves. Quora, a startup that has raised nearly $300 million over 14 years, most recently at a $2 billion valuation, two weeks ago filed a corporate charter update that authorizes it to issue only common stock rather than the preferred stock investors previously got. In a cram-down financing, investors who don’t put in new money often lose their designation as preferred shareholders, meaning they no longer get paid out first in a sale or liquidation. Adam D’Angelo, Quora’s CEO, declined to comment.

Plans or discussions for financings at Turntide, Nuro, Indigo and Quora haven’t been previously reported.

Becki DeGraw, a partner at law firm Wilson Sonsini Goodrich & Rosati who advises both startups and venture capital firms, said more of her startup clients have started to ask her for advice on down-round deal structures as cash runs low. She is coaching them on concepts like cram-down financings, as well as penny warrants allowing investors to buy additional shares in a company for a nominal price, which can help offset valuation pain.

“The deals we’re going to see are going to be messier and more complex,” DeGraw said.

Quiet Down Rounds

More than 900 private companies passed the $1 billion threshold between 2021 and 2022, according to Crunchbase, when money was cheaper and public tech stocks soared. Some young startups were able to raise at valuations that were 100 times their low annual revenues.

As stocks fell into a bear market, private valuations mostly remained frozen as founders who had taken advantage of free-flowing investing dollars drew down cash and laid off workers. Some firms cobbled together bridge financings, small checks typically raised between larger rounds, from existing investors or raised debt, maintaining their earlier valuations. There were notable exceptions, such as Stripe’s funding, which lowered its valuation to $50 billion from $95 billion.

“Companies were basically doing everything they could to avoid down rounds,” said Will Ballard, an analyst at Lagniappe Labs, which runs a private markets index for startups.

But startups now are running out of options. Some are quietly raising more-traditional down rounds, in which they sell shares at lower prices than they had previously. Rho Technologies, a New York–based startup that offers corporate cards and expense management software, in May raised $40 million at a $385 million pre-money valuation in a round led by early-stage venture firm M13. That was about 10% lower than Rho’s prior pre-money valuation of $425 million. The down round, which hasn’t been previously reported, came despite the firm’s forecast of a 2.5 times increase in revenue this year, to $50 million, a person familiar with the matter said.

The leaders of Clumio, an enterprise software startup, knew their next round of capital would likely come at a steep discount to the roughly $700 million valuation the company earned in 2019 after a bidding war between investment firms. CEO Poojan Kumar told prospective investors in June he expected closing a new financing would mean a significant valuation cut, estimating that it would be up to 50%, the person said. Whether Clumio raised the new financing could not be learned. Representatives for Clumio didn’t respond to requests for comment.

Already, down rounds have been accelerating as a portion of the relatively few startup deals that are getting done. They represented about 30% of all startup financings in the first quarter this year, the last period for which data was fully available, according to Wilson Sonsini. That was roughly triple the portion of down rounds the firm had tracked per quarter since 2018.

A cram-down financing typically carries a particular stigma. But that reputation may soften over the next year as so many companies follow through with down deals after having raised at such inflated valuations.

“It’s kind of an odd expectation that in the private markets [prices] only go up,” said Matt Harris, a partner at Bain Capital Ventures.

Nuro, the robotics company valued two years ago at more than $8 billion, asked its board for additional capital to grow the business but was rejected, a person familiar with the matter said. The company laid off employees and reduced commercial operations of its autonomous-delivery robot. It also pivoted its business model to cut costs. Some of its investors have pushed for a sale, while others have discussed a potential cram-down financing that would cut its valuation, according to two people familiar with the matter.

After this article published, Nuro founder Jiajun Zhu said in a statement that the company had never asked for additional capital from the board and that “no investor has pushed Nuro for a sale, nor have our leadership discussed a cram-down financing with our board or investors.”

Still, the reckoning could take an emotional toll across the tech world, as founders have to admit to employees that the rocket ship they thought they were building is less valuable than they previously imagined.

Wayne Ting, chief executive of Lime, a scooter- and bike-rental startup, said he has gotten a couple of inquiries from other startup leaders who asked about his experience with a major down round. Lime, once one of Silicon Valley’s hottest startups, completed a cram-down round three years ago as the pandemic temporarily halted its business. His message: “It’s going to be hard. It’s going to be hard with your employees. It’s going to be hard with your investors, who were there for you when no one else was.”

Still, Ting is glad he did it. Lime later added debt and cut costs, and it now has “a real shot” to generate free cash flow by the end of the year, he said. “The reality was it was the best outcome because the alternative would have been bankruptcy,” Ting added.

Turntide, the electric motor firm, expects to raise enough new cash to give the firm a runway to achieve profitability within two years, CEO Morris said. Most of the firm’s existing investors are putting more money into the firm at lower prices, he said, reducing some of their potential dilution.

The new funding would help his firm continue to work on a “20-year problem in climate tech,” he said. “That means [making] some really tough calls in the short term.”