Down rounds in Asia: ‘Eating shit is horrible, but it’s far better than suicide’

Image by Benjamin Child

In Asia – particularly markets in Southeast Asia where investment amounts are by and large undisclosed – it’s often you’ll hear of startups getting funded and later receiving follow-on rounds as an indicator of growth and success. At least, the perception of success is what’s intended by founders and stakeholders in the region. Don’t worry guys, everything is just peachy with us! What’s rare, however, is getting wind of an otherwise promising Asian startup accepting what’s known as a “down round.” For those who are VC savvy, the words create a spine-chilling sensation more potent than scenes from The Exorcist.

Don’t know what a down round is? US tech blog Pando cites an episode from the popular HBO TV series Silicon Valley as a good explainer. Essentially, the main character Richard is presented with a massive series A offer that would include a US$20 million investment at a US$100 million valuation. As Richard’s startup Pied Piper (a new kind of compression engine) is still a baby, another character explains to him that he should not accept the offer. In theory, it would allow investor hype to set the bar too high for Richard’s fledgling company. In theory, this could result in the startup not being able to match the valuation on the next round, a round that would name a valuation based on actual results, as opposed to initial investor confidence. The following investment would be a “down round,” in which the company’s valuation shrinks.

Down rounds are often seen as bad because they indicate a startup is bleeding out, instead of thriving as it should be. Often the new firm is indeed growing, albeit at a slower than projected pace, and the valuation target set by the previous round was simply too high. In more opaque markets like Indonesia (sorry to say it), entrepreneurs and VCs congratulate one another for each round raised, but rarely discuss valuation in public.

See: 10 Indonesian startups with consistent funding and growth

Scarlet letter

Teddy Himler, vice president of SoftBank China and India Holdings, tells Tech in Asia Southeast Asia’s tech markets may simply be too nascent at this stage to start seeing and analyzing down rounds.

“I haven’t seen a single one with a down round,” says Teddy, who spends most of his time in Jakarta and can tell you whatever you need to know about the local market. “That said, everyone always thinks of a down round as a scarlet letter. You know, you have to wear this hideous mark. In fact, I think it’s appropriate that investors and entrepreneurs continue to calibrate and recalibrate on value.”

He adds that often in Southeast Asia, startups are taking convertible note seed investments (short-term debt that converts into equity upon raising a series A investment), which means they won’t really have to worry about a down round on the series A investment because no valuation was assigned from the get-go. “I think you start to see down rounds when you see the same investors coming into the round again,” says Teddy, who says naturally there are exceptions, as in the case with Whatsapp taking all its rounds from Sequoia prior to the Facebook acquisition.

Cersei from Game of Thrones prepares for her walk of shame. Startups that have taken down rounds likely know the feeling (Promo image from HBO).

Willson Cuaca, managing partner at East Ventures, one of the most active early stage investors in Southeast Asia, takes a more pessimistic stance. “Down rounds are actually really bad,” he says. “When a founder accepts a down round, that means he’s accepted the reality that he is not performing. If there are stock options to the employees, they will know the company is not performing well. For the co-founders and executives, it will demoralize them.”

See: Getting funding: 10 survival strategies for startups

Psychological effects

Valuation isn’t everything