Why VC’s Don’t Want to Lead Down Rounds

Accounting, Bookkeeping, Finance, HR, and Tax for Startups.

Need help with your startup’s bookkeeping, finance, or taxes? Visit Kruze to see if our team can help you! https://kruzeconsulting.com/

Video Transcript:

Hey, it's Scott Orn at Kruze Consulting. And today we're answering the question, why don't VCs like to lead down rounds?

And the reason why this question is popping up a lot is with COVID and the associated economic fallout, there's a lot of pressure on valuations and raising money has gotten a lot harder than it's been over the last couple of years. And so, some entrepreneurs are being faced with down rounds or maybe just contemplating them, and what does that mean for the company? Well, there's one thing that's super important to know, and that's, VCs actually don't like leading down rounds.

And there's a couple reasons for that. First of all, and I'm talking about outside VCs, not VCs that are already invested in the company. VCs that are invested in the company, they will typically do a bridge round, they'll help the company get through, that's part of being a good VC and part of being a good board member. But sometimes those VCs are tapped out, and so the entrepreneur has to look to an outside VC to lead a round. And there're some reasons why outside VCs don't like to do it. The first is, it can really make your referral network as a VC mad.

People generally know this, but VCs refer each other deals. So, a top-tier series A investor, I always like to say has series B and series C investors on their speed dial. They have five funds that they really like to work with. And so if those funds were to kind of come at their companies in an opportunistic way to try to lead down rounds and wash out those series A investors, well, that's ruining the relationship there. So those series B, series C investors are very aware of that. And so they gently gracefully bow out of most down round opportunities.

The second reason is that the follow-on investors actually know that VC firms force rank their companies. And the VC firms know their top companies. And so they're always gonna support the top companies in the portfolio. So, if you're a later investor and you're getting the opportunity to lead a down round, well, that means it's probably not the greatest situation, it's not in the top 50% of that other VC fund's investment. So, that makes you worried a little bit again.

And the third reason is, it can be a huge waste of time, because a lot of these times, the internal VCs are just looking for a fairer price. They've been negotiating a down round or inside round with the founder, but no one knows how to price it. And so by getting an outside investor to put a price on the round, you've done the job that everyone's looking for. They can get the term sheet, they know what the price is, but that doesn't mean they have to sign the term sheet and actually take the money.

Oftentimes what I see is, the internal VCs will just do the round at that price. That means the outside VC has done a ton of due diligence, risks making their referral network mad, and for what do they get out of it? Nothing, they don't even get the deal.

So those are three reasons why VCs don't like doing down rounds. Hope that helps. Thanks.