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When does raising a structured round make more sense than accepting a valuation reduction?

The decline in venture capital financing that began in early 2021 persisted until the end of 2022, and there are few indications that it will reverse course anytime soon. Who spells further bad news for young companies that are trying to seek capital.

Many firms who avoided or relied on alternatives to a standard funding round in 2022 will be in a difficult liquidity situation this year and will need to attempt to raise.

In order to get the necessary cash, the company may have to raise a down round, which involves financing at a lower valuation than the prior, or undertake a transaction with legal terms and structure designed to give downside protection to investors.

Many business founders won’t get to choose whatever contract they prefer, but for those who can, there are several considerations to bear in mind.

In recent months, a number of investors have resorted to social media and the press to argue that firms would be better off accepting a down round and a lower value rather than negotiating a deal that takes into account everyone’s desires. However, there is a certain amount of leeway given to founders.

Our goal here is not to provide legal advice, but all the talk about down rounds has had me thinking: Is that preferable to a regular round format? Is there any risk even if investors promote down rounds? So that I would have a clearer picture, I consulted with various legal professionals.