Structuring Down-Round Financing: Anti-Dilution Protections, Employee Considerations, Mitigating Board Conflicts

Description

The current economic environment has required many startups to seek down-round financing, in which the company has a reduced valuation from its prior financing round. Down rounds have important implications for employees and existing investors and can involve complex structuring concerns. Boards and controlling shareholders must consider any conflicts of interest and the risk of shareholder actions in response to such financing.

Stock options or other equity awards are important tools for retaining key personnel. Down-round financing reduces the value of employee stock awards and the prospects for a profitable exit. Boards may need to consider additional equity awards or a management carve-out plan to prevent key employees from departing.

Directors have a fiduciary duty to their shareholders and may have conflicts of interest, resulting in litigation from shareholders or creditors negatively impacted by the down round. To mitigate this risk, a board might consider the appointment of an independent committee to evaluate the proposed transaction, a disinterested stockholder vote, or a rights offering for existing shareholders.

Down-round financing may be further complicated by anti-dilution provisions in favor of preferred shareholders, which may allow them to receive a more favorable conversion rate and enhanced voting rights due to the new round of investment. Before proceeding, the parties will need to determine when a conversion occurs and how it will be documented.

Listen as our authoritative panel discusses these and other nuances of down-round financings.