My friend and colleague Siqi Chen, never afraid to question the status quo, wrote a comment questioning the wisdom of “not pricing a round of financing too high”:
“Whenever I hear advice about pricing a round too high for the next round, I can’t help but think: well, if the choice (ceteris paribus) is between
a) doing what is effectively a down round preemptively when I don’t have to, by underpricing my current round in this market vs
b) accepting the market price along with some risk of taking a down round in the future, if I don’t hit my milestones,
why would I ever choose b)?”
Mark Suster then responded with a good post about the psychology of down rounds on fundraising, best summed up as, “a down round is even more complicated than having no demand for your investment round.”
That is true, but we also shouldn’t ignore the psychological impact on the team should a down round actually get done.
If you’ve ever been part of a public company with a collapsing stock price you’ve got an idea of what this does. Skeptics on the team start to win arguments, especially when the founders aren’t in the room. It can be quite hard to keep trust with the team, especially since you’ve now shown poor judgement as a leader by guiding the team to this down round. That can feel doubly worse if it was a self inflicted wound caused because you over-optimized on price previously.
And although I made the analogy to a public company stock price, in practice it is much worse than that because you are by definition in a much more vulnerable state. Sure, the team may believe in your long term vision, but that is balanced against their calculus about whether it is actually going to happen. And you just added a whole lot of doubt to that.
In worst case scenarios I’ve spoken to founders who have nicely growing companies, but have a team that has become suddenly demoralized despite their success because of the down round they just were backed into.
Imagine you are coaching a basketball team and you are always saying, “we are going undefeated the next 10 games no matter what!” then you may have set an audacious goal but keeping people’s faith is going to be tough over the long term. And winning eight games suddenly feels like failure when it may have been great. The best founders, and coaches, take it one game at a time, continually building one brick on top of the other.
Managing the psychology of success has a massive impact on everything from ability to hire, to fundraising, to retaining talent, to team cohesion, to ability to do bizdev deals.
It’s worth keeping in mind that it is a balance between price, dilution, capital, investors, founders, and team. As with most things, nothing is free so just be certain you understand what you are giving up if you are pushing one part of this equation abnormally high.