Down rounds, when a private company offers shares for sale at a lower price than shares were sold during the previous financing round, are typically seen as overtly negative. However, in today’s uniquely volatile conditions they can also be a strategic win that could lead to long-term success.
So Says Dean Quiambao, CPA partner and Northern California market leader in the San Ramon office of Armanino LLP, a nationwide accounting and business consulting firm. Quiambao shares his insights on the challenges CFOs can face in preserving capital, making strategic hires and preparing for increased uncertainty.
What should be the number one focus for CFOs who are considering a down round?
The number one focus for CFOs considering a down round should be building a company that lasts, which can be done by maximizing performance and cash. They need to have clearly identified growth drivers, but more importantly, they need to show a path to profitability.
This involves carefully assessing the current financial situation, understanding the reasons for the down round and developing a strategic plan to navigate through the challenging times. Key areas of focus may include cash runway modeling, optimizing cash flow, managing costs and investing in efficiency.
Down rounds often carry a negative connotation, could you lay out an example or two of how a “successful” down round can be a positive during difficult times?
While down rounds are generally seen as a negative event because they indicate a decrease in a company’s valuation, they can still be beneficial in certain situations.
A down round can bring in new investors who see potential in the company’s long-term prospects, despite the temporary setback. These investors may provide additional capital, expertise and valuable connections, strengthening the company’s position and increasing its chances of success.
In some cases, a down round can help align the company’s valuation with the current market conditions and performance. It can be an opportunity to reset expectations, improve transparency and establish a more realistic valuation that reflects the company’s true value. This can lead to a more stable and sustainable foundation for future growth.
It can also be a defining moment and act as a lightning rod for the whole organization to really get priorities straight. By taking a step back and saying, “This is what we are and this is what we are doing,” it allows everyone to take a hard look at the business with a critical eye and reset their focus.
Beyond extending the runway, are there any other ancillary benefits to taking a down round that executives should consider?
Going through a down round demonstrates a proactive approach to addressing financial challenges and signals to existing and potential investors that the company is taking necessary steps to preserve its value. This transparency and willingness to address issues can strengthen trust and enhance relationships with stakeholders.
Down rounds often coincide with a more stringent focus on cost control and operational efficiency. This disciplined approach can lead to a more sustainable business model, improved financial discipline and increased chances of future profitability.
Down rounds give a company’s leadership the ability to ensure that everyone who is on the team is wanting to be on the team and those who don’t want to be there aren’t. Everyone knows it’s crunch time, and that will weed out some of the bad eggs. I like the saying, “We are in the era of getting fit,” because it’s true from a lifestyle perspective and is wildly accurate from an operational business perspective. Revisiting your people strategy is a great way to make sure your company is fit.
What steps can CFOs take to mitigate potential risks and challenges associated with a down round?
Conduct a comprehensive assessment of the company’s financial health, including cash flow projections, debt obligations and capital requirements. This analysis will help identify the extent of the financial challenges and inform the decision-making process.
Create a detailed plan outlining specific actions to address the financial challenges and navigate through the down round. This may involve cost-cutting measures, optimizing operations, exploring new revenue streams or seeking additional funding sources.
Maintain transparent and open communication with existing investors, employees and other stakeholders throughout the down round process. Clearly communicate the reasons for the down round, the steps being taken to address the situation, and the long-term strategy for recovery. This helps build trust and alignment among stakeholders. CFOs should also develop very clear questions about how they’ll use the funding, being deliberate about their dollars.
Engage with experienced legal, financial and strategic advisors who have expertise in down rounds and financial restructuring. Their guidance can help navigate the complexities involved and mitigate risks associated with the process.
Identify the company’s core strengths and competitive advantages, and leverage them to create a solid foundation for recovery and future growth. This may involve doubling down on key products or services, targeting specific customer segments or exploring new market opportunities.
Each company’s situation is unique, and it’s essential to tailor the approach to the specific circumstances and seek professional advice when necessary.