Investor-protective deal terms may keep down rounds at bay

On May 20, 2022

Down rounds continue to make up a very small portion of total venture capital deals, with just 5% of completed rounds in Q1 coming at a smaller valuation than a company’s previous raise, according to PitchBook’s latest US VC Valuations Report.

That figure could change in coming quarters if market headwinds persist. But before there is a significant growth in down rounds, venture-backed companies will likely see a rebound of investor-protective deal terms, said Kyle Stanford, a senior analyst at PitchBook.

“The competition for deals we have seen over the past few years helped to see many of these [protective] terms dropped from deals, but now as capital availability tightens, investors can insist on more aggressive terms to bring the financing market back toward their favor,” said Stanford.

A decline in down rounds over recent quarters came roughly hand in hand with the decline in protective deal terms, including those that govern whether investors will receive additional compensation after their liquidation preference has been paid out.

“Investor-protective deal terms should help a lot of these companies raise at least flat rounds,” said Stanford.

Capital availability is another factor that could soften the rise of down rounds in coming quarters. US VC firms raised a record-shattering $131.5 billion in 2021, representing a 54% year-over-year increase over 2020’s fundraising figure of $85.3 billion.

While the number of funds raised in the past few years will help retain investor participation, inflation, interest rates and other headwinds will likely cause firms to increase their scrutiny of deals, lowering the revenue multiples that valuations have been raised at in recent years, according to PitchBook data.