154. Valuations are Down; Down Rounds Are Up

VC Minute
As fundraising constricts, investor-friendly terms come out. Understand the effect these terms have on you and your company, as well as the effects of stacking SAFEs.

VC Minute – quick advice to help startup founders fundraise better.

Click below to listen. 4m 12s duration.


Subscribe to your podcast platform of choice.

Listen on Apple Podcasts
Listen on Spotify
Listen on Google Podcasts
Listen on Amazon Music
Listen on Pocket Casts
Listen on Stitcher

If we look back, unfortunately, to late 2021 or early 2022, a lot of those founders took term sheets that look pretty silly at the moment right now. And you’re seeing a lot of companies having to do down rounds or bridge rounds, or getting really creative to keep money coming in the door because the valuation is just too high.

I think founders should, while they’re shooting for big valuations, just keep in mind that you wanna make sure you are right-sizing the valuation to the growth of the business and the potential that you see. And you’re really just trying to do that math in your head and say, what do we need in order to get to the next big milestone that’s probably two years away? And then how much does that back into what my company is worth?

We could spend an hour and a half on valuations in general. As a topic, let’s just talk about it and disambiguate the idea of valuation at the Pre-seed level, and then valuations within Seed and Series A.

At the Pre-seed, if you are raising on a convertible note or a SAFE, the reason that you’re doing that is to explicitly avoid valuing your company. And that’s for the sort of obvious reason that it’s incredibly difficult to value an idea or a very early company. Just kind of slapping a 10 million valuation on a business that was started three months ago, it’s not very precise.

A lot of times, the investor and the founder in this case agree to explicitly not set a valuation and let that valuation get set by somebody down the road. And that’s why the equity converts when that valuation is set during the price round.

Of course, you may hear from investors, yes, that’s true, but if you have a valuation cap on your safe, you’re effectively setting a valuation on your business. I can understand that argument, but it really isn’t the same thing.

What we’re seeing right now is that with all the turmoil that’s going on, startups have kind of suffered this valuation decline over the last 18 months after flying really high in 2020 and 2021.

For pre-seed companies, the median valuation cap on a safe that we’re seeing is just about $10 million. Just below, about 9.5 million for a standard pre-seed safe. And companies are raising, on average, I think, something like $600,000 on that safe. Not from one investor. That’s, that’s quite a few investors, usually in those rounds.

When you jump up to seed, the median seed valuation on Carta at the moment is 13.1 million. And the amount of cash that’s raised in a given seed round is anywhere from Three to three and a half million dollars is a pretty good median there. If you jump up to Series A, you’re talking about a 40 to 42 million valuation, and you’re raising about 10 million bucks.

When you jump up to seed, the median seed valuation on Carta at the moment is 13.1 million. And the amount of cash that’s raised in a given seed round is anywhere from. Three to three and a half million dollars is a pretty good median there. If you jump up to Series A you’re talking about a 40 to 42 million valuation, and you’re raising about 10 million bucks.

So that gives you a little bit of insight into how it jumps up through these stages.

One big topic that comes up here that founders should be aware of is downrounds. So down rounds are just like what they sound, it’s taking on new fundraising at a lower valuation than what you had previously been valued at.

And for a while they were kind of, to be candid, a black mark on a company’s prospects. And that’s for two reasons. One when you take a down round, obviously you are implicitly stating, hey, we were overvalued, and we need to rethink things.

But the hidden side of that is oftentimes you issued equity to employees and others at an inflated valuation. And so, you have to go back to your employees oftentimes and explain to them that their equity is not worth what they thought it was worth. In fact, it might be that their exercise price is now higher than the fair market value of their equity. So, they’re unlikely to even exercise those stock options. And that’s a really tough place to be as a founder.

A good data point for you all to know is that close to 20% of all of the rounds on Carta in Q1 of 2023 were down rounds. This is not just happening to a few companies, it’s happening to a lot of companies because of the way the macro environment has changed.

It’s my hope that down rounds become a little bit less of a stigma. There’s certainly nothing to shoot for, but there have been great businesses that have been built after they take a down round. So, it is by no means the end of a company. But it does entail some difficult trade-offs.

About Carta
Carta builds infrastructure for tomorrow’s innovators. Founders can manage their equity, issue options, and pay fairly using Carta Cap Table and Compensation tools. You can get a weekly peek into data from 38,000 startups across the world by subscribing to our Data Minute newsletter.


Visit the VC Minute homepage for more episodes and more ways to subscribe.


Picture of VCMinute
VCMinute

About Us

We are in the business of helping young companies grow through seed investment and access to our network of leaders and industry experts.  People first. 

Recent Posts

Sign up for our Newsletter