When a founder hears the words "Down Round" and "Cramdown" in the context of their company, the first reaction is usually defensive. That makes perfect sense if you consider a "Down Round" or "Cramdown" an adverse event in general.
Ironically, it appears that two of the most significant venture backed exits of the year, SpringSource's acquisition by VMWare this week and OpenTable's IPO in May, had a DownRound and a Cramdown respectively on their way to leading hope for a return of VC liquidity events.
In fact, if you combine OpenTable's day one market capitalization to the total consideration for SpringSource's acquisition, the dollar amount exceeds $1 billion. To put that number into perspective in the current environment, it's roughly 5X greater than the value of all venture backed internet, software, and media/communications companies acquired in Q2 of 2009 (based on NVCA data).
More importantly, these adjustments in pricing (also known as "dilutive issuances" in the case of Down Rounds and "reorganizations" in the case of Cramdowns) may have had a much more detrimental effect on investors than they did on founders.
The charts that follow illustrate why, in many cases, founders that survive a Down Round or a Cramdown through a company's ultimate acquisition or IPO a) usually make out better than many of the VCs in the deal and b) ALWAYS make out better than companies that fail to secure the next venture round needed to stay in business.
So this first example is based on capitalization data Liquid Scenarios extrapolated from an 8K filing by VMWare concerning their acquisition of SpringSource. Based on that data, it appears SpringSource's Series A round was priced at $1.031 per share, whereas their Series B round was priced at approximately $0.887 per share. By definition, that's a Down Round.
If you look at the related estimated payout for Founders you will not that the system projects 1,000X returns after the Down Round. Moreover, it's common that other management incentives, such as stock options, are either re-priced or that additional options are granted at a lower price to management following a Down Round.
Even though Benchmark Capital invested in SpringSource's first round, their cash-on-cash return multiple is projected to be slightly lower than Accel Partners', because their average cost per share is slightly higher, as a result of what appears to be Down Round based on VMWare's 8K filing.
So, as you can see in this example, the Founders' still made out well despite the Down Round. However, the investors in the prior round had a more material adverse event as a result of the dilutive pricing.
Around April of 2003, it appears that OpenTable's Series A, Series B and Series C stock originally issued to a large group of investors was converted (crammed down) to common stock. In order to maintain liquidation preferences, control and any hope of substantial upside, venture capitalists had to put even more money into the company, or end up with only common stock.
Two firms that did continue to invest were Benchmark Capital and Impact Venture Partners. The diagrams above are from Liquid Scenarios estimates as of April 11, 2003, which show the state immediately prior to the New Series A. If Benchmark Capital and Impact Venture Partners had not put additional cash into the deal, the slope of their payout line would be almost exactly like the slope of management's payout line. However, their return multiple would be substantially lower than it was prior to the Cramdown, whereas management's would still be thousands times more than their cash investment. Most of the investors in OpenTable's original Series C, Series B and Series A rounds had return curves similar to what's shown above, because they were unable or unwilling to put additional cash in at the lower valuation.
So if you are ever faced with the possibility of a Down Round or even a Cramdown, the best defense may be sticking around. If you can, it's possible that your deal could end up as a top IPO or acquisition.
Coaster Image Source: Design Gone Wild
All other graphics, diagrams and callouts generated in Liquid Scenarios(R).
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Startup/Business
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Since founding bpCentral, our focus has been on increasing each user's competitive advantage each and every time they interact with one of our applications. Naturally, this involves more than simply enabling complex calculations to be performed accurately. In fact, during the first 12 months of developing our new technologies and applications, we put an inordinate amount of resources into discovering how to transform the relationships between idiosyncratic decision-makers and financial information. Our premise was that if that human to data relationship could be elevated to a new standard, then the relationships of those professionals with the entities and individuals they interact with could be more efficient and therefore more valuable.
In response, we developed CIMPA, the Carver Import Algorithm, a system that allows any electronic financial information, data or reports to be interpreted by a receiving system without the need for XML, XBRL, tagging approaches or extensive manual data entry. As a result of this technology, the Company's systems for private equity and venture capital professionals are able to import data in a matter of seconds, instead of a matter of hours.
Similarly, the Company noted that when users attempted to calculate the outcomes of complex liquidation preferences, anti-dilution provisions and other complex terms that are common to VC/PE transactions, any output was virtually impossible to verify without a costly audit of the formulas. Since the formulas were generally based in excel, this meant that few if any partners or other key investment professionals could afford to expend the effort to verify how amounts were arrived at. Upon further consideration, the Company realized that, to a certain extent, this was true of all financial reports. For traditional financial statements, this point is evidenced in the fact that notes to financial statements typically occupy several times more pages than the actual financial reports do. This realization inspired the Company to develop a system it calls OferX, which presents all financial information in a manner that allows any user to audit and see how amounts were calculated (in an easy to understand, quantifiable manner) without the need for extensive textual descriptions.
Together these unique tools form the foundation for the Company's offerings, which are backed by over 29 patent pending technologies.
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