Corporate Finance & Accounting

next round

What is the next round?

A next round is when a private company sells additional shares at a lower price than the previous round.

In short, more capital was needed, and the company found its valuation was lower than it was before the last funding round. This “discovery” forced them to sell their share capital at a lower price per share.

key takeaways

  • A next round is when a private company sells additional shares at a lower price than the previous round.
  • Company valuations are subject to variables (failure to meet benchmarks, emergence of competition, venture capital funding) that cause them to be lower than they were in the past.
  • The next round could result in lower ownership percentages, loss of market confidence, and negatively impact company morale.

Learn about the next round

Private companies raise capital through a series of financing stages, called rounds. Ideally, the first round should raise the required funds without the need for subsequent rounds. Sometimes startups burn much higher than expected, leaving companies with no choice but to raise another round.

As the business grows, it is expected that successive financing rounds will be executed at progressively higher prices to reflect the rising valuation of the company. The reality is that a company’s actual valuation is subject to variables (failure to meet benchmarks, emergence of competition, venture capital funding) that can cause it to be lower than it used to be. In these cases, investors would only consider participating if the stock or convertible bond was issued at a lower price than the previous funding stage. This is called the next round.

While the earliest investors in a startup tend to buy at rock-bottom prices, subsequent rounds of investors have the advantage of knowing whether the company can meet stated benchmarks, including product development, key hires, and revenue. When benchmarks are not met, subsequent investors may insist on lowering the company’s valuation for a variety of reasons, including concerns about inexperienced management, early hype versus reality, and questions about the company’s ability to execute on its business plan.

Businesses with a clear advantage over the competition, especially in lucrative fields, are often well-positioned to raise capital from investors. However, if this advantage disappears due to the emergence of competition, investors may seek to hedge their bets by demanding lower valuations in subsequent funding rounds.

Typically, investors compare competing companies’ product development stages, management capabilities, and various other metrics to determine a fair valuation for their next funding round.

Even if a company does everything right, the next round may come. To manage risk, venture capital firms often demand lower valuations, along with measures such as board seats and participation in the decision-making process. While these situations can result in significant dilution and loss of control for company founders, the involvement of a VC firm may provide what the company needs to achieve its primary goals.

Impact and Alternatives

While each financing round typically dilutes the ownership percentage of existing investors, the need to sell more shares to meet financing needs increases the dilution effect.

The round of declines underscores the possibility that the company may have initially been overhyped from a valuation standpoint and now can only sell shares at a discount. Such a perception could negatively impact market confidence in a company’s profitability and deal a major blow to employee morale.

Alternatives for the next round are:

  1. The company lowered its burn rate. This step is only feasible if there is operational inefficiency, otherwise it is self-defeating as it may hinder the company’s growth.
  2. Management may consider short-term or bridge financing.
  3. Renegotiate terms with existing investors.
  4. Close the company.

Financing through financing is often seen as a company’s last resort due to the potential for significant declines in shareholding, loss of market confidence, negative impact on company morale, and unattractive alternatives, but it may be its only chance to stay in the business.

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