A Down Round Hurts Less Than the Preference Stack Above It

In November 2013 Basho Technologies avoided a down round, and the round it took instead helped carry it into receivership. A Delaware court later found that its valuations reflected an investor’s insistence on “avoiding the optics of a down round”. The lower price was never the danger. The liquidation preferences stacked above the company were.

Basho’s investor Georgetown Basho Investors, which held blocking rights over new financings, proposed a $20M Series G at a $75M pre-money valuation. Georgetown committed $10.025M, but only $2.575M was new money, about 13% of the headline round (our arithmetic); the rest converted amounts due under an existing loan. The stock carried a 3x liquidation preference, an 8% cumulative dividend and the right to designate five of the seven directors (Basho v. Georgetown, 2018). Outside investors stayed away, and in 2016 Basho was liquidated.

A down round sells new shares below the previous round’s price. What repels the next investor is a stack of liquidation preferences larger than the company is now worth, and the down rounds that work clear it, through pay-to-play or a recapitalisation offered to every holder.

Exhibit 1. Five ways to raise below the last price, and what each does to the preference stack

Route	Price per share	Preference stack after the round	How common	Main risk
Down round, stacked	Lower, openly	Grows by the new money, paid side by side	32% of Cooley’s deals at the Q1 2024 peak	New money shares losses with the old stack, so it asks for seniority
Structured round	Flat or higher headline	Grows by a senior or multiple preference	Senior preferences in 56% of Fenwick’s Q2 2002 deals	Hidden terms deter the next investor
Pay-to-play	Lower	Shrinks: holders who do not invest lose their preference	10.1% of Cooley’s deals in Q2 and Q3 2025	Friction with the holdouts
Recapitalisation	Lower, often with a reverse split	Reset: old preferred converts to common	3.2% of Cooley’s deals in Q3 2025; 20% of Fenwick’s in Q1 2002	A fiduciary claim if insiders run it
Inside round	Set by existing investors	Usually grows	Mostly backstop financing, on one study’s evidence	Entire-fairness review in Delaware

Source: Cooley (2024, 2025); Fenwick & West (2002); Broughman and Fried (2012). Fenwick counts “corporate reorganizations” and Cooley “recapitalizations”; the definitions differ.

Basho’s Series G avoided a down round and grew the stack

Vice Chancellor Laster found that “Basho’s valuations appeared to have more to do with Davenport’s insistence on avoiding the optics of a down round than with any principled valuation techniques”, Chester Davenport being Georgetown’s managing member. An email in the record said: “I have never heard of a customer not buying technology because the valuation in the current round was lower than the last.”

The stack also gave Georgetown a reason to block the alternatives. When a rival investor, Southeast, offered terms, Davenport told his team that Georgetown would “play along with them until time runs out”, and later said Georgetown would not consent to any deal that reduced its liquidation preferences. The Southeast deal died. Georgetown and Davenport were held liable for $17,490,650 in damages, and the Delaware Supreme Court affirmed in 2019 (Davenport v. Basho, 2019).

Bill Gurley had described the pattern in 2016. Structured term sheets, he wrote, produce gains for the investor “not from the headline valuation, but rather through a series of dirty terms that are hidden deeper in the document”. And “no new investor will want to live on top of the termy round” (Gurley, 2016). His advice was blunt: “Terms are the true Godzilla that should scare you to death. A down round is nothing.”

Preferences above the company’s value keep new money out

Corporate finance described the mechanism in 1977. Stewart Myers showed that a firm carrying risky debt “will, in some states of nature, pass up valuable investment opportunities”, because its owners will fund a project only if its value exceeds the outlay plus “the promised payment to the firm’s creditors” (Myers, 1976). Part of what new money creates goes to the old claim, so good projects go unfunded: debt overhang.

A liquidation preference behaves like that debt whenever a sale would come in below it. New money that joins a stack worth more than the company pays part of its return to the claims beside it, so it asks for seniority, a lower price or a smaller stack. The quantity to compute is the excess of preferences over value.

Preferences above value = liquidation preferences outstanding − equity value today

The software company in Exhibit 3 is hypothetical. Founders and employees hold its 20.0M common shares. In 2021 it raised a $4.0M seed at $1.00 a share, a $16.0M Series A at $4.00 and a $40.0M Series B at $10.00, for a post-money valuation of $320M and $60M of 1x non-participating preferences. Its equity is now worth $45M and it needs $15M, so its preferences exceed its value by $15M. The cut is deliberately deep, 86% below the Series B price against Fenwick’s 2004 averages of 54% to 56%, because the problem belongs to deep cuts.

Exhibit 3. One hypothetical company, four ways to raise $15M, $M

Structure	Preference stack after the round	Founders and employees receive in a $60M sale	In a $120M sale	Founders and employees paid only above	New money back in a $60M sale
1. Down round stacked on the old preferences	75	0.0	36.9	75	12.0
2. Flat headline price with a 3x senior preference	105	0.0	15.0	105	45.0
3. Pay-to-play: Series B holders fund $10M, seed and Series A convert	55	3.6	41.4	55	15.0
4. Recapitalisation: all old preferred converts to common	15	28.1	56.3	15	15.0

Source: our calculation for the hypothetical company above. New money buys at $1.40625 a share (a $45M pre-money) except in structure 2, which holds $10.00. Each preferred series takes the greater of its preference and its as-converted share. Anti-dilution adjustments are left out; they change who gets the upside in a large sale and leave the size of the stack alone.

In the stacked round, a sale at exactly the new post-money value of $60M returns $12.0M of the $15M, or 80%, because the proceeds are split across a $75M stack. Few outside investors would accept that, and the founders’ shares pay nothing below a $75M sale. Preferences differ from Myers’s debt in two ways that matter here. They rarely have a maturity or a default, so the excess starves the company instead of forcing it into bankruptcy, and their holders usually sit on the board that negotiates the round.

Structure 2 is the Basho route. It holds the price at $10.00 and the headline post-money at $335M, and the founders’ as-converted stake looks better, 59.7% against 46.9%, but the stack rises to $105M. Founders and employees receive nothing below a $105M sale, and they do better than under the recapitalisation only above $247.3M, about 4.1 times the company’s current post-money value.

Pay-to-play and recapitalisation make the holdouts choose

Clearing the excess means persuading the holders of old preferences to give some up, and each holder would rather the others did. Pay-to-play turns that holdout into a choice. The National Venture Capital Association’s model charter includes a sample provision. A preferred holder that does not buy its pro rata share of a qualifying round, after at least 10 days’ written notice, has some or all of its preferred converted into common (NVCA, 2025). In structure 3, the Series B holders pay and keep their preference, the seed and Series A holders do not and convert, and the stack falls from $75M to $55M. The charter’s weighted-average anti-dilution formula cushions earlier investors against a lower price but leaves their preferences intact.

A recapitalisation goes further and converts all of the old preferred. In structure 4, founders and employees receive $28.1M in a $60M sale, and the old investors $16.9M against $48.0M in the stacked round. That transfer is why recapitalisations are fought over, and why pay-to-play is the more common tool: holders who keep funding the company keep their place in the stack.

Downturns bring the down rounds first and the cleanup later

In the second quarter of 2002, about 52% of the 74 Bay Area technology companies the law firm Fenwick & West analysed raised in a down round (Fenwick & West, 2002), and the share reached 73% in the first quarter of 2003 (Fenwick & West, 2004). In early 2004 the average down round priced shares 56% below the previous round (Fenwick & West, 2005). Down rounds peaked at 22% of rounds on Carta in 2023 (Carta, 2025) and at 32% of the deals Cooley handled in the first quarter of 2024 (Cooley, 2024), then fell to 11.4% on Carta in early 2026 (Carta, 2026). The three sources sample different companies, so they show the shape of each downturn rather than a comparable level.

Exhibit 2. Two downturns in three datasets: terms hardened only in the first

	2002 to 2003	2022 to 2025
Down rounds at the peak	73% of financings, Q1 2003 (Fenwick)	32% of deals, Q1 2024 (Cooley); 22% of rounds, 2023 (Carta)
Preference terms	Senior preference in 62% (Q1 2002) and 56% (Q2 2002) of financings; multiples in 58% and 41% of those	1x non-participating in about 94% of deals, Q1 2024 (Cooley)
Pay-to-play	20% (Q1 2002), 18% (Q2 2002)	8% (Q1 2024); peak of 10.1% (Q2 and Q3 2025)
Recapitalisation	20% (Q1 2002), 11% (Q2 2002)	2.5% (Q1 2024); peak of 3.2% (Q3 2025)

Source: Fenwick & West (2002, 2004, 2005), 45 to 112 Bay Area technology financings a quarter; Cooley (2024, 2025), 202 to 238 financings a quarter handled by the firm, with recent quarters restated in later reports; Carta (2025, 2026), rounds on its platform.

In the second downturn the price fell first, and the tools that clear a stack peaked five to six quarters later. Pay-to-play reached a record 10.1% of Cooley’s deals in the second quarter of 2025 (Cooley, 2025), and recapitalisations 3.2% in the third (Cooley, 2025). The advice founders received barely changed between the two. Sequoia Capital’s October 2008 deck opened a list of new realities with “$15M RAISE @ $100M POST IS GONE” (Sequoia, 2008). Its slides headed “Recovery will be long” and “Survival of the Quickest” returned in the firm’s May 2022 deck with matching chart labels (Sequoia, 2022); only the date had changed, from 10/08 to 5/2022.

Delaware tests the process when insiders set the terms

A board’s financing decision normally gets the business judgment rule. When the directors’ own funds buy the new stock, the directors must prove the deal entirely fair, a test with “two basic aspects: fair dealing and fair price”. In Carsanaro v. Bloodhound Technologies, the founders alleged that the directors’ funds set the terms of a 2001 Series D without contacting outside investors. For the 2002 Series E, “the directors negotiated with themselves”, and took a 3x preference. When Bloodhound was sold in 2011 for $82.5M, the founders and developers held under 1% and received less than $36,000 between them (Carsanaro, 2013). On a motion to dismiss, the court took those allegations as true and put the burden of proving fairness on the defendants.

In January 2002 the insiders of Nine Systems recapitalised the company on a valuation of $4M set by an individual affiliated with a major shareholder, and the plaintiffs’ stake fell from about 26% to about 2%. In 2006 it was acquired for about $175 million. The court found a breach of the duty of loyalty: a director who represented minority holders had been “knowingly excluded”, and the process was “grossly inadequate”. But it also found that the equity was worth “$0” before the recapitalisation, so the price was fair and no damages followed. After an eleven-day trial, the court awarded $2M of the plaintiffs’ $11.4M in fees and costs (Nine Systems, 2015).

Exhibit 4. Three Delaware cases about financings in a downturn

Case	Financing	What the directors did	What the court decided
Carsanaro v. Bloodhound (2013)	Series D (2001) and E (2002)	Set terms without outside investors (as alleged)	Directors must prove entire fairness; claims went forward
In re Nine Systems (2014, 2015)	Recapitalisation (2002)	Excluded a minority director; inadequate process	Breach of loyalty; fair price, so no damages; $2M in fees
Basho v. Georgetown (2018)	Series G (2013)	Used blocking rights to force insider terms	Not entirely fair; $17.49M in damages; affirmed in 2019

Source: the opinions linked in the text.

Directors work for the residual claimants, “the ultimate beneficiaries of the firm’s value, not for the benefit of its contractual claimants” (In re Trados, 2013), and Delaware gives no stockholder a preemptive right to new stock unless the charter grants it (8 Del. C. § 102(b)(3)). A rights offering on the directors’ terms is a choice the board has to make.

Is a fair process affordable when the cash is short?

Sequoia’s 2022 deck ranked new money last among a company’s options: raise equity or debt “even if it is expensive”. In a downturn the only willing buyers are often the existing investors, and a special committee, a market check and a rights offering take time that a company short of cash may not have. The evidence on insiders is also kinder than the cases suggest. Brian Broughman and Jesse Fried, studying Silicon Valley startups, “find little evidence that VCs use inside rounds to dilute founders”. Inside rounds serve mostly as backstop financing at relatively high valuations, perhaps to reduce litigation risk (Broughman & Fried, 2012).

Speed does matter, and Broughman and Fried’s sample suggests most insiders are not predators. Even the Nine Systems court allowed that the company’s limited financial means might explain its weak valuation work. Most of what went wrong in the cases cost no time to avoid, though. Nine Systems turned on the exclusion of a director and the failure to keep stockholders informed. Basho became a $17.5M judgment because a holder blocked the alternatives and then imposed its terms. The NVCA’s model pay-to-play provision needs only 10 days’ notice.

Compute the excess before reading the term sheet

Founders whose next round will price below the last should subtract a realistic sale value from total liquidation preferences before reading any term sheet. Every proposal deserves a waterfall at the post-money value, twice it and four times it. A lower price on standard 1x terms, with pay-to-play if the existing investors are needed, beats a flat price with a senior preference; the dilution calculator below models the waterfall.

Preferred holders and directors should let disinterested directors or the stockholders approve any insider-led round and test the market first, the steps missing in Carsanaro (as alleged) and Nine Systems. Consent rights used to hold out for preferences cost $17,490,650 in Basho. Pay-to-play shares the rescue among existing investors rather than handing it to one.

A down round is a price, and a price can recover: Nine Systems was recapitalised at a valuation of $4M and sold four years later for about $175M. What does lasting damage is a stack of preferences above the company’s value, which repels new money for the reason Myers gave in 1977, and the structured rounds that grow the stack while hiding the price. Survival does outrank terms, which argues for taking the lower price quickly and the senior stack never. Whether this downturn’s cleanup is over remains open: recapitalisations peaked at 3.2% of Cooley’s deals in the third quarter of 2025, against 20% of Fenwick’s in the first quarter of 2002, and the two firms count different deals.

Notes and sources

• Broughman, B. J. and Fried, J. M. (2012). Do VCs use inside rounds to dilute founders? Some evidence from Silicon Valley. Journal of Corporate Finance 18(5), 1104–1120.
• Carta. State of Private Markets: Q3 2025 (Neville and Dowd, 2025), Q1 2026 (Neville, 2026).
• Cooley LLP. Venture Financing Report: Q1 2024 (2 May 2024), Q2 2025 (12 August 2025), Q3 2025 (3 November 2025).
• Carsanaro v. Bloodhound Technologies, Inc., 65 A.3d 618 (Del. Ch. 2013).
• Basho Technologies Holdco B, LLC v. Georgetown Basho Investors, LLC, C.A. No. 11802-VCL (Del. Ch. July 6, 2018), aff’d sub nom. Davenport v. Basho Technologies Holdco B, LLC (Del. Oct. 22, 2019).
• Delaware Code, Title 8, § 102(b)(3).
• Fenwick & West LLP. Trends in Legal Terms in Venture Financings in the San Francisco Bay Area: Q2 2002, Q2 2004 and Q4 2004.
• Gurley, B. (2016). On the road to recap. Above the Crowd, 21 April.
• In re Nine Systems Corporation Shareholders Litigation, Consol. C.A. No. 3940-VCN (Del. Ch. May 7, 2015), letter opinion on fees, summarising the post-trial opinion of 4 September 2014.
• In re Trados Inc. Shareholder Litigation, 73 A.3d 17 (Del. Ch. 2013).
• Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics 5, 147–175; quoted from MIT Sloan Working Paper 875-76 (1976).
• National Venture Capital Association. Model Amended and Restated Certificate of Incorporation, with commentary (October 2025).
• Sequoia Capital (2008). R.I.P. Good Times (presentation to portfolio companies, October); (2022). Adapting to Endure (presentation to founders, 16 May).

The figures come from the law-firm and platform surveys, court opinions, model documents and papers listed above; Myers is quoted from his 1976 working paper, and the Nine Systems findings as the 2015 fee opinion records them. Numbers that name no source are calculated from the surveys, opinions and documents cited, and the company in Exhibit 3 is hypothetical. The piece describes Delaware law and US practice and offers no legal advice.