- Down-rounds, Re-Pricings, and Recaps Increase — The current macroeconomic environment, coupled with record increases in valuations over the last several years, is creating an increase in down-rounds, re-pricings, and recapitalizations. The exponential rates of valuation increases seen over the last few years are gone and, particularly for capital-intensive companies that raised cash in 2021 or 2022 and/or companies that did not meet their projected development goals and growth rates over that period, companies and existing investors are bracing for down-rounds and, potentially, re-pricings of prior rounds. Recaps will come in many forms, but most will share a common theme: pay up or lose your rights. These deals generally include some version of a pay-to-play, whether through a traditional cramdown mechanic or a pull-up mechanic. Regardless of the structure, balancing investor expectations regarding ownership levels and upside payouts, while keeping management and other employees incentivized through cash and equity compensation, will be critical to ensure continued growth for companies.
- De-risking Investments — Investors are feeling the pain in their portfolios, and they are looking for possible ways to de-risk and increase return rates for new investments. Standard convertible preferred stock and pari passu series that have been the norm for the last decade are giving way to senior securities with accruing dividends, guaranteed multiple returns, and/or participation features. Some investors also are looking for the right to force a sale in shorter timeframes (i.e., 18-36 months), which can create misalignment of incentives among early and late-stage investors and/or management/common stockholders.
- A Focus on Governance and Management Accountability — Investors will be hyper-focused on their portfolio companies’ development and growth progress and ability to stay within the budget and business plan. Founders and management teams will have less freedom to make mistakes and investors may look for ways to hold the management team accountable, such as through enhanced governance and consent rights for investors and altering management compensation structures to include more performance-based compensation (cash and equity). Gone (for now) are the days of “total founder control” involving founder super-voting stock, voting proxies, and total Board control.
- Expanding Deal Timelines — Venture capital funds still have funds to invest, but they will take longer to approve an investment, in part because they are doing more due diligence – kicking the tires several times – and negotiating harder on terms. This means deal timelines are stretching. Companies looking to raise capital should make sure they have plenty of runway when planning the timing of their next capital raise, expect funding delays, and have a back-up plan for a short-term bridge (e.g., convertible notes).
- Deal Sourcing Moving to New Markets — With new hubs for startups popping up throughout the U.S. and abroad since 2020, investors may look for deals in “secondary markets” with lower costs, including markets where fund managers have relocated over the past few years (such as Florida, Texas, Colorado, and Utah). On the other hand, some investors may pull back and focus on investing in their backyard in traditional markets so they can keep an eye on their investments and visit more often in-person, dropping by the office for lunch to check in on the business.
About the Authors:
Greenberg Traurig Shareholder Chinh H. Pham is co-chair of the firm’s Venture Capital and Emerging Technology Practice.
Greenberg Traurig Shareholder Emily Ladd-Kravitz is co-chair of the firm’s Venture Capital and Emerging Technology Practice.
Greenberg Traurig Shareholder Bradley A. Jacobson is a Shareholder in the firm’s Venture Capital and Emerging Technology Practice.
About the Practice:
Greenberg Traurig’s Venture Capital and Emerging Technology Practice, a multidisciplinary legal team focused on representing entrepreneurs and investors. The group guides emerging technology companies through all the stages of their development, from initial business formation through angel, venture capital, and cross-over financings to initial public offerings and exit transactions. In addition, they advise institutional investors in their investments into innovative companies at all stages and across industries.