Here’s Everything You Need To Know About Washout Round

Here’s Everything You Need To Know About Washout Round

Washout Round

A washout round in venture capital slashes existing investors’ ownership, especially common shareholders’, in startups during funding rounds.

What Is A Washout Round?

A washout round, in the context of venture capital and startup financing, is a funding round in which the ownership stakes of existing investors, particularly common shareholders, are significantly reduced or ‘washed out’. 

This typically occurs when a company is in financial distress or experiences a sharp decline in its valuation, and new investors are willing to invest at a much lower price per share. In a washout round, the new investors may demand more favourable terms and a higher ownership percentage in exchange for their investment, which can dilute the ownership of existing shareholders.

What Is Washout In Trading?

In trading, the term washout refers to a situation where a security’s price experiences a rapid and sharp decline, often breaking through key support levels. It can lead to heavy selling and panic in the market and may trigger stop-loss orders or margin calls. Washouts can occur in stocks, commodities, or cryptocurrencies, and are typically characterised by a significant drop in the price of the asset.

What Is A Cram Down?

A cram down in venture capital refers to a situation where new investors in a funding round negotiate terms that are unfavourable to existing investors, particularly early-stage investors and common shareholders. This can include issuing new shares at a lower valuation, which results in the dilution of the ownership stakes of the existing shareholders. Cram downs are often used when a company is struggling or requires additional capital and new investors aim to secure a more significant share of the company at the expense of existing stakeholders.

What Is The Difference Between A Down Round And A Cram Down?

Down Round: A down round is a funding round in which a company raises capital at a lower valuation compared to the previous round. In a down round, all shareholders experience dilution as the company’s valuation decreases. This can happen for various reasons, including financial difficulties or changes in market conditions.

Cram Down: A cram down doesn’t necessarily involve a lower valuation for the company. Instead, it pertains to the negotiation of unfavourable terms in a funding round that disproportionately impacts existing investors. This can include the issuance of new shares with preferential terms to new investors, reducing the ownership percentage and influence of existing shareholders.

What Is The Cram Down Process?

It typically involves a negotiation between new investors and the company’s management to secure more favourable terms for the new investment. These terms can be detrimental to existing investors, leading to the dilution of their ownership stakes and influence in the company. The exact process may vary depending on the specific circumstances, negotiations, and the level of financial distress the company is facing.