A down round happens when a company raises capital by selling shares that are valued lower than the last time they raised funds. Because it is calculated by multiplying the amount of shares outstanding by the cost of a share, a company's valuation therefore usually plummets. While each funding round typically results in the dilution of partnership percentages for existing stockholders, the need to sell a higher number of shares to meet financing necessities in a down round increases the dilutive effect. When this happens, the business needs to explore new ways to motivate and retain employees that are concerned about the liquidity of their underwater stock options. Here's how companies can go about it:
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Cash bonus policy
In a cash bonus plan, an organisation guarantees a certain amount of money to employees in the event of an acquisition. This amount can equal a pre-established sum or a percentage of the net sale proceeds that will be allocated to the employees at the time of the sale. These allocations can be based on a wide range of parameters, thus enabling a high degree of flexibility. A cash bonus policy is not only easy to understand but also provides the employees with money to pay any taxes that may be due.
Introducing a new class of equity
A stock bonus or option plan uses a new class of equity. This approach has several advantages. Firstly, unlike a simple issuance of additional options, it gives real value to employees that were affected by a decline of their common stock. Secondly, unlike the cash bonus policy, it does not require an acquirer to put up cash when the company is purchased. Also, a new class of equity will not affect the tax-free nature of many stock-for-stock acquisitions. The best thing about this option is that it provides certainty to the employees, who know exactly what they will be entitled to receive when the company is eventually sold.
If the common stock has been compellingly reduced to minimal value by the down round, a company could hike the common stock value through recapitalisation. Recapitalisation can be applied through a decrease in the liquidation preferences of the favoured stock or a conversion of some favoured stock into common stock, thereby increasing the share of the proceeds that are distributed to the common stock upon the sale of the organisation. This solution is conceptually straightforward and majorly effective in increasing the value of the common stock. However, implementing a recapitalisation would require the consent of the affected preferred stockholders, which may be challenging to obtain as they may not like the permanency of this approach.
If you manage to retain your important employees through a down round, there is very little that your competition will be able to do to steal them away in the future. It is, therefore, imperative to take measures to preserve your best talent during challenging times for the better future of your company.