Cram-downs are back, and I’ll keep a list.
At the turn of the century after the dotcom crash, startup valuations plummeted, burn rates were unsustainable and startups quickly ran out of money. Most existing investors (still in business) hoarded their money and stopped doing follow-up rounds until the rubble was cleared up.
Except, that is, for the bottom feeders of the venture capital business – investors who “cram” their companies. They offered desperate founders more money, but pushed for new terms and rewritten all the old stock deals that had previous investors and employees.
For existing investors, it was sometimes “pay-to-play” – if you don’t participate in the new financing, you lose. Other times it was just a “take-it-or-leave-it, here are the new terms” deal. Some even insisted that all previous preferred stock be converted to common stock.
For common shareholders (employees, advisors and previous investors), a cram down is a big middle finger, as it involves a reverse split – meaning your common stock is now worth 1/10e1/100e or even 1/1,000e of their previous value.
A cram-down is different from a down round. A downward round is when a company raises money at a valuation that is lower than the company’s valuation in the previous funding round. But it doesn’t come with a huge reverse split or change in terms.
While the cram-downs never went away, the flow of capital over the past decade meant most companies could just raise another round.
But now that economic conditions are changing, that is no longer true. Startups that can’t find the product market, generate enough income, or don’t have patient capital, are scrambling for dollars — and the bottom feeders are happy to help.
Why do VCs do this?
VCs will come up with all sorts of reasons why – “it’s just a good thing” or “we’re opportunistic”. On the one hand, they are right. Venture capital, like most private equity, is an unregulated financial asset class – anything goes. But the simpler and more painful truth is that it is offensive and usurious.