A down round is a funding round in which a startup sells shares at a lower price per share than in its previous round. It means investors now value the company below what earlier investors paid. Startups fear down rounds because they hurt in three ways at once: existing shareholders are diluted more than usual, protective clauses held by earlier investors can shift even more ownership away from founders and employees, and the news itself damages morale, hiring and future fundraising.
What exactly counts as a down round
The test is the price per share, not the headline valuation. Law firm Cooley’s startup resource defines it as a round in which a company sells shares “at a price per share that is less than the price per share it sold shares for in an earlier financing” (Cooley GO).
Two related terms are often confused with it:
- Flat round: new shares are sold at the same price as last time. No gain, but no loss.
- Mark-down: an investor lowers the value at which it carries a startup in its own books. No new shares are sold, so it is not a round at all, though it often signals that one may come.
Why down rounds happen
- The last round was priced too high. Valuations set in a funding boom can be hard to justify once markets cool.
- Public-market comparisons fall. Late-stage private valuations are often benchmarked against listed peers. When those share prices drop, private prices tend to follow.
- Missed milestones. If revenue, growth or margins fall short of what the last round assumed, new investors pay less.
- Running out of cash. A company with little runway has weak bargaining power and may have to accept a lower price to survive.
- Company-specific trouble. Governance problems, legal disputes or a loss of investor confidence can make new money scarce.
Two well-documented cases show the range. Swedish payments company Klarna raised $800 million in July 2022 at a post-money valuation of $6.7 billion, down from $45.6 billion in June 2021; it said the round closed “during the steepest drop in global stock markets in over fifty years” (Klarna). In India, edtech company Byju’s launched a $200 million rights issue in early 2024 that, TechCrunch reported, valued it about 99% below the $22 billion valuation it reached in 2022; major investors including Prosus and Peak XV did not take part, and a group of investors led by Prosus sought to remove the founder from leadership.
Anti-dilution: how earlier investors protect themselves
Most venture investors in India hold compulsorily convertible preference shares (CCPS), which convert into equity shares at a set conversion price (see How startup funding works in India). Anti-dilution clauses lower that conversion price if a later round is cheaper, so the earlier investor gets more equity shares on conversion. Those extra shares come out of everyone else’s stake, mainly founders and employees.
There are two main types.
Full ratchet
The earlier investor’s conversion price drops all the way to the new, lower price, regardless of how much money the down round raises. It is the most protective for the investor and the harshest for everyone else.
Broad-based weighted average
The conversion price is reduced by a formula that considers both how much lower the new price is and how much money is raised relative to the company’s size. A widely used form is:
New conversion price = Old price × (A + B) ÷ (A + C)
where A is the number of shares outstanding before the round on a fully diluted basis (including options), B is the number of shares the new money would have bought at the old price, and C is the number of shares actually issued in the down round (Cooley GO). Cooley describes this as the more commonly used approach. A small down round barely moves the price; a large one moves it more.
Illustrative example (hypothetical, round numbers)
A Series A investor paid ₹100 a share for 10,00,000 CCPS (₹10 crore). The company has 1,00,00,000 shares on a fully diluted basis. It now raises ₹10 crore in a Series B at ₹50 a share, issuing 20,00,000 new shares.
| Full ratchet | Broad-based weighted average | |
|---|---|---|
| New conversion price | ₹50 | ₹100 × (1,00,00,000 + 10,00,000) ÷ (1,00,00,000 + 20,00,000) ≈ ₹91.67 |
| Equity shares Series A investor gets on conversion | 20,00,000 | about 10,90,909 |
| Extra shares versus no protection | 10,00,000 | about 90,909 |
Under full ratchet the Series A investor doubles its share count. Under weighted average it gets about 9% more. In both cases the extra shares dilute founders and employees.
An Indian wrinkle
For foreign investors, India’s foreign-exchange rules add a limit. The RBI’s Master Direction says the conversion price of convertible instruments “should not in any case be lower than the fair value worked out, at the time of issuance” (RBI). That can limit how far an anti-dilution clause can actually cut the conversion price for a non-resident investor, so Indian deals sometimes use other mechanisms to achieve a similar effect.
What a down round does to employees and ESOPs
- Underwater options. If the new share price is below your exercise price, exercising makes no financial sense. Your options still exist, but they are worth little unless the price recovers.
- More dilution. Anti-dilution adjustments and the larger number of shares issued at a low price both shrink the percentage that the ESOP pool and employee shareholders own.
- Retention problems. When options lose value, staff may leave. Companies sometimes respond by repricing options or issuing fresh grants, which further dilutes existing holders.
For how ESOPs are granted, vested and taxed, see ESOPs explained.
Alternatives to a down round
Companies often try hard to avoid a lower headline price. Common approaches include:
- Flat round. Raise at the previous price, accepting no step-up.
- Bridge or convertible financing. Existing investors lend or invest through convertible notes to buy time until results improve, postponing the price question (Cooley GO).
- Structured terms. Keep the headline price but give new investors stronger rights instead, such as a higher liquidation preference (getting paid back first, sometimes a multiple of their money), participation rights or warrants. The valuation looks intact, but the economics for ordinary shareholders can be worse than a clean down round.
- Anti-dilution waivers. Earlier investors agree to waive their adjustment, often in return for something else, so a cheaper round does less damage.
- Cutting costs to extend runway. Spending less can reduce or delay the need for new money.
None of these is free. A structured round can quietly transfer value to new investors, and a bridge only helps if the business improves before the money runs out.
The point: A down round sells shares cheaper than last time, and anti-dilution clauses can push most of the cost onto founders and employees. Full ratchet protection is far harsher than broad-based weighted average. Alternatives such as flat rounds or structured terms can hide a down round without removing its cost, so read the terms, not just the headline valuation.
Sources
- What you need to know about down round financings, Cooley GO
- Klarna closes major financing round during worst stock downturn in 50 years (11 July 2022), Klarna
- Byju’s says $200M rights issue that cuts valuation by 99% fully subscribed (20 February 2024), TechCrunch
- Master Direction – Foreign Investment in India, Reserve Bank of India