Flat round

What Is a Flat Round?

A flat round, in the context of venture capital finance, refers to a fundraising event for a private company where new equity is issued at the same per-share valuation as the company's previous funding round. This outcome indicates that, despite raising additional capital, the company's perceived value by investors has not increased. Flat rounds are distinct from "up rounds," where the valuation increases, or "down rounds," where the valuation decreases. They represent a neutral outcome regarding a company's market perception between investment stages, often occurring during periods of market uncertainty or when a company's growth has stalled.

History and Origin

The concept of a flat round, while not tied to a specific historical invention, emerged naturally within the evolution of venture capital funding. As the private markets matured and multi-stage funding became common, the need to describe various valuation outcomes between capital raises became apparent. The term gained prominence particularly after major economic shifts or market corrections, such as the dot-com bubble burst in the early 2000s or the financial crisis of 2008, when companies found it challenging to secure higher valuations. In more recent times, even with significant investment in areas like artificial intelligence, global venture capital funding experienced a substantial decline in the first half of 2023, reflecting a broader lack of investor enthusiasm and higher interest rates.⁶ Such market conditions often lead to a greater prevalence of flat rounds as investors become more selective.

Key Takeaways

• A flat round means a company raises new capital at the same per-share valuation as its previous funding round.
• It signifies no change in investor-perceived valuation between financing stages.
• Flat rounds can occur due to challenging market conditions, slower-than-expected growth, or a strategic decision to avoid valuation adjustments.
• While not ideal, a flat round is generally preferable to a down round, which involves a reduction in valuation.
• Understanding the context of a flat round requires examining a company's financial statements and growth trajectory.

Formula and Calculation

A flat round does not involve a specific formula for calculation, as it primarily describes the relationship between the pre-money valuation of the current round and the post-money valuation of the previous round. The key determinant is the per-share price.

If (P_c) is the per-share price of the current round and (P_p) is the per-share price of the previous round, a flat round occurs when:

This equality indicates that investors are purchasing new shares at the same price as the last investment, implying that the company's underlying valuation has remained constant for the purpose of this capital raise. The total capital raise in a flat round will still increase the company's overall capitalization and typically leads to shareholder dilution.

Interpreting the Flat Round

Interpreting a flat round requires a nuanced understanding of a company's situation and the broader market. While an up round is generally seen as a sign of strong progress and increased valuation, a flat round can be a mixed signal. In a robust market, a flat round might indicate that a company has not met its growth milestones or that its market opportunity has not expanded as initially projected. However, in a challenging economic climate, securing a flat round can be viewed positively, as it demonstrates continued investor confidence and the ability to raise additional capital without a "haircut" to the prior valuation.

For instance, a company might accept a flat round to extend its cash runway, allowing more time to achieve key performance indicators before seeking a higher valuation. It also avoids the negative perception and potential morale issues associated with a down round. Companies undergoing due diligence by new investors might experience a flat round if those investors perceive the previous valuation as fair but not undervalued enough to warrant an immediate increase.

Hypothetical Example

Consider "InnovateTech," a fictional software startup that successfully raised a Series A Funding round at a post-money valuation of $50 million, with 10 million shares outstanding. This implies a per-share price of $5.00.

After 18 months, InnovateTech needs to raise more capital for expansion. They have achieved some milestones but also faced unexpected market competition, impacting their projected growth. They approach investors for a Series B round, seeking $10 million in new funding.

During negotiations, investors analyze InnovateTech's updated financial statements, market position, and future prospects. While they are willing to invest the $10 million, they determine that the company's progress, while steady, does not warrant a higher per-share price than the Series A. Consequently, the Series B round is closed at a per-share price of $5.00.

To raise $10 million at $5.00 per share, InnovateTech issues 2 million new shares ($10,000,000 / $5.00 per share). The company's new post-money valuation is $60 million (previous $50 million + $10 million new investment), but the per-share valuation remains constant. This is a classic example of a flat round. Existing shareholders experience dilution as their percentage ownership decreases, even though the per-share value of their common stock remains unchanged from the previous round.

Practical Applications

Flat rounds are a practical reality in the world of private equity and venture capital. They manifest in several scenarios:

• Bridge Financing: Companies often raise bridge financing as a short-term capital raise to extend their operational runway until market conditions improve or until they hit specific milestones that could justify a higher valuation in a subsequent major round. These bridge rounds are frequently flat rounds.
• Market Corrections: During periods of economic downturn or market volatility, investor appetite for risk may decrease, leading to a re-evaluation of high growth potential without the previous exuberance. In such environments, many companies may find themselves unable to achieve an up round and opt for a flat round to ensure continued funding. Reports from sources like Reuters indicate a recent slump in global venture capital funding, which can increase the likelihood of flat rounds.⁵
• Strategic Reset: A flat round can also be a deliberate strategic choice. Rather than engaging in a down round, which can negatively impact employee morale and future fundraising, a company might prefer a flat round to maintain positive investor relations and signal stability, even if growth has decelerated.
• Regulatory Scrutiny: The Securities and Exchange Commission (SEC) regulates the offer and sale of all securities, including those issued by private companies.⁴ While the SEC's primary mission is investor protection, the terms of a flat round (or any funding round) are typically negotiated between the company and investors, adhering to various regulations like those under Regulation D.³

Limitations and Criticisms

While a flat round avoids the negative optics of a down round, it is not without its limitations and potential criticisms.

One primary limitation is the implicit signal it sends: a lack of significant progress that would justify a higher valuation. For venture-backed startups, continuous value appreciation is often expected, and a flat round can raise questions among existing shareholders and prospective investors about the company's long-term growth trajectory or the effectiveness of its management. It may suggest that the company hasn't achieved the milestones anticipated from the previous investment, or that the market for its product or service hasn't expanded as rapidly as initially hoped.

Furthermore, a flat round still results in dilution for existing shareholders, including founders and early employees. While the per-share value remains the same, their percentage ownership in the company decreases with the issuance of new shares. This can impact the potential return on their initial investment upon a future exit strategy, such as an Initial Public Offering or acquisition.

Critically, a series of flat rounds could indicate deeper underlying issues within the company or a persistent struggle to scale effectively. It might suggest that the business model is not as robust as initially believed or that the competitive landscape has become more challenging. While the PwC MoneyTree Report tracks investment trends, the nuances of individual company performance within these broader trends are crucial for understanding the implications of a flat round.²

Flat Round vs. Up Round

The distinction between a flat round and an up round lies entirely in the company's valuation between successive funding rounds.

An up round is the desired outcome for most startups and their investors, signifying successful execution and increasing investor confidence. Conversely, a flat round, while not as detrimental as a down round, suggests that the company's market perception or performance has stagnated in terms of valuation. Investors participating in an up round typically gain a higher paper return on their initial investment, reflecting the company's enhanced value.

FAQs

How does a flat round affect employee stock options?

A flat round means the strike price for new stock options issued might remain the same as the previous round, or it might be set slightly higher or lower based on the board's internal valuation. For existing options, their value typically holds steady or experiences no significant paper loss, unlike in a down round where options can become "underwater" (strike price higher than current valuation).

Is a flat round a bad outcome for a startup?

Not necessarily. While an up round is always preferred, a flat round can be a reasonable outcome, especially in challenging market conditions. It allows a company to secure additional capital without compromising its previous valuation, which can be crucial for extending operational runway and avoiding the negative implications of a down round. The American Bar Association provides resources on navigating venture capital, underscoring the complexities involved.¹

What causes a company to raise a flat round?

Several factors can lead to a flat round. These include slower-than-expected revenue growth, failure to hit key performance indicators (KPIs) set during the previous round, a general tightening of the venture capital market, or increased competition in the company's sector. Sometimes, it can also be a strategic decision by the company to prioritize cash over a higher valuation if they believe they can achieve significant milestones with the new capital.

How do flat rounds impact future fundraising?

A flat round can make future fundraising more challenging, as investors may look for significant progress and a clear justification for a higher valuation in subsequent rounds. Companies might need to demonstrate substantial growth and market traction to move from a flat round to an up round. However, successful execution post-flat round can restore investor confidence and pave the way for more favorable terms in the future.