A down round describes the scenario for a round of capital financing in which the pre-money valuation of a company is below the post-money valuation of its previous round of capital financing. There are several possible reasons why a company may be subject to a down round, including one. The company is underperformed and has failed to reach the financial or operational benchmarks established at the last capital round. Particularly in a strong economy, a down round can be seen that a company's growth is slowing. Two, overall valuations have dropped in a particular sector or more broadly across the VC marketplace due to negative macro issues such as rising interest rates. Three, shifting momentum in investment markets from founder friendly terms to investor friendly terms, or vice versa to return to a balanced approach for valuation. Four, a negative internal company issue impacting companies financials such as a lawsuit or a large asset write down, however, down rounds can also be viewed positively as an opportunity for founders to get their metrics and path to profitability in order. Sometimes a negative environment creates an opportunity for companies to address high cash burn rates or cost inefficiencies or to rethink their growth strategy, none of which would've been addressed in a positive or booming investment cycle. Similarly, investors may be lured back to invest in the company at a more realistic valuation to help the company overcome their challenges and to get back on track. In addition to a lower valuation other funding terms of a down round are usually more favorable to the new investor.

VC investors in a down round often negotiate to include other favorable terms such as a higher liquidation preference at two or three times, or a full participating preference feature, which enables new investors to get their money back in whole and share pro rata on the remaining proceeds or anti-dilution provisions.

In a down round, the new investors have more negotiating power as there has been some sort of negative event or stall in the company's growth, which means it is seeking additional investment and prepared to do so at a lower valuation. Shares that are purchased in a down round will be less expensive than those bought in the last round.

For a company that needs to raise capital, a down round scenario is not a welcome development to existing shareholders. Their investment has declined in value and they will also have to absorb a greater level of dilution to raise the same amount of money than if the value of the business had not declined. And to venture investors who report Their illiquid holdings to their limited partners on a mark to market basis, it inevitably means a write down in the carrying value of the investment and a drop in the reported fund returns.