Down in the dumps: startups’ funding woes
Down round analysis, Better Collective M&A extra +More
Welcome to this month’s edition of The Startup Month. As has been obvious to those keeping an eye on the betting and gaming startup scene this year, there has been a comparative dearth of (announced) new funding rounds.
So this month we look into one of the factors that has been going on in the background for the past 12 months or more and helps explain the apparent drying of the well when it comes to growth company funding – the potential for down rounds.
But first, some M&A news from Better Collective.
Looking at life through the eyes of a tire hub.
M&A extra
Better Collective has announced its second-largest acquisition, snapping up the Toronto-listed sports media and gaming affiliate business Playmaker Capital for €176m in cash and shares.
Playmaker owns the media sites Futbol Sites, Yardbarker and the Nation Network as well as the affiliate Wedge. It has a focus on the LatAm and North American markets.
The deal involved 65% shares with the remaining 35% being settled in cash.
Based on trailing 12 months EBITDA of €15m the multiple is over 11x.
Better Collective said there was a “clear path to synergies post integration”, which would bring the estimates of EV/EBITDA for 2026 to below 5x.
Strategic fit: Playmaker was founded by Jordan Gnat and quickly built a portfolio of media and affiliate assets via acquisition. In its Q3 earnings, the company said it generated pro forma revenues for the three months to June of C$12.6m ($9.2m) and pro forma adj. EBITDA of C$3.3m.
The acquisition is in line with Better Collective’s long-term strategy to be seen as much as a sports media player as an affiliate.
Deep down
The dreaded phrase ‘down round’ has been more prominent in the betting and gaming startup sector vernacular this year.
Down beat: During a panel appearance at the recent G2E conference in Las Vegas, Lloyd Danzig, principal at Sharp Alpha Investments, made the comment that the frequency of “down rounds and recapitalizations is elevated compared to previous years”. This despite the details of these financing rounds being rarely announced publicly.
At issue is the number of companies that, given the tricky economic backdrop and the very poor outlook for funding, are finding that to raise more money from investors they are needing to go for lower valuations.
Using the terminology, such events occur when the pre-money valuation on new investment is less than the post-money valuation on the previous fundraising round.
“They typically take place when companies run out of cash or fail to meet investor expectations,” Danzig tells E+M.
Big picture, small picture: This can be when there is a major change in market dynamics or when macro funding conditions and revenue multiples have tightened significantly. Jesse Wachtel, co-founder at Huddle, says down rounds occur for both micro and macro reasons.
“Micro meaning specific to that company’s performance: if revenue growth has slowed or the next big innovation that is supposed to drive adoption goes over like a lead balloon, investors will mark down the company’s valuation,” he says.
“Macro reasons usually apply to larger companies and later rounds, but if the equity market is suffering or the cost of capital goes up, investors are likely to price that into a company’s valuation as well.”
Chasing rainbows: Getting to the specifics, Benjie Cherniak, principal at Avenue H and a serial angel investor himself, points out that from 2019-21 the betting and gaming space saw a ‘gold rush’ mentality predominate, leading to market inflation that has “proven unsustainable for many startups”.
“Companies were being bought and sold based on multiples and valuation metrics that seemed plausible at that time, but would not be as feasible today,” he says.
Meanwhile, the same applies with companies seeking capital.
“Many companies raised at the height of the market on the assumption that the iGaming space would remain elevated.
“Now the market in general and gaming in particular has come back down to earth, some of those founders have had to raise at a lower valuation than they had previously as a matter of survival.”
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Right of refusal
Thanks, but no thanks: Down rounds are not welcomed by existing investors for obvious reasons and it means that whether they will participate will always hang in the balance. “Existing investors typically have a first right of refusal but don't always participate in down rounds,” says Danzig.
On the one hand, non-participation from existing investors can send a negative signal to new prospects.
“Especially in the current market, a lack of insider participation is often a result of the investor’s financial situation or strategy change, but it can still damage the perception of the company’s well-being,” says Danzig.
“Insider-led down rounds can come together quickly when investors maintain confidence in the management team and the company’s growth trajectory. Fundraising is more challenging when existing investors are not participating.”
Bridge building: Perhaps because of the optics, then, involvement from previous investors is more likely than not. Wachtel points out that while their investment might be seen as a sunk cost, they should be open to persuasion that the new, lower valuation makes sense as long as the reasons for the original investment remain in place.
“Also previous investors might be willing to invest in a bridge to better times to protect their already committed capital,” he says.
“When a company is unable to raise new capital at preferable terms, we often see existing investors agreeing to pony up additional dollars at a flat valuation or even a slight bump up,” says Cherniak.
“This is, in particular, the case if the investors feel some success is around the corner such that they conduct a bridge raise to keep the company afloat in the hope that a bigger raise can then be achieved at a more favorable valuation in the not too distant future, thus avoiding a down round altogether.”
The damage done: Down rounds aren’t just a financial issue. They also present challenges to the company management and its staff in terms of confidence and performance. Some of this is technical. As Danzig points out, while “smart investors” won’t be deterred by the optics, the “anti-dilution protection” triggered for existing investors can result in” incentivization challenges for the management team and other stakeholders”.
“Down rounds also present challenges to employees who typically receive options with exercise prices pegged to the valuation of the company at the time they joined,” he adds. “Maintaining employee incentivization after a down round often requires re-striking option agreements or issuing more options to employees.”
As Wachtel notes, there is a balance that founders should “try to achieve between adequately funding their business and the commensurate dilution”.
“If you believe your hockey stick moment is only around the corner, raising a smaller bridge round even at a depressed valuation may make sense.”
“Founders often get punished for overpromising and under-delivering, so it is always good to raise enough capital even for your more bearish scenario.”
Survival strategies: Whether a company can survive a down round, and all the implications it means about past performance and future prospects, is a different matter. “The realization of a down round is generally not viewed favorably by staff and can lead to morale challenges, as staff worry about job security, bonuses and general career growth opportunities,” says Cherniak.
“The immediate question asked internally is why?” suggests Wachtel.
“The answer might be obvious to many if the company has underperformed, but often macro conditions do play a major factor and individual staff members may be less aware of these types of contributing elements,” he adds.
“I think for some management and staff, it might be deflating especially if, let’s say, they were issued stock options at a higher price than the last valuation.”
Look on the bright side: The realization on the part of those working for the company that all might not be well when it comes to its funding prospects presents another tricky hurdle for management to negotiate.
“The realization of a down round is generally not viewed favorably by staff and can lead to morale challenges, as staff worry about job security, bonuses and general career growth opportunities,” says Cherniak.
“That said, a strong management team will accentuate the positives that come with raising fresh capital and in turn steer the ship in a favorable direction,” he adds.
“This can thus minimize concerns related to valuation that could negatively impact company morale.”
Lengthening runway: Wachtel points out that the reason for “fresh capital in the door at whatever valuation” is it gives the business in question “more runway to accomplish the company’s goals”.
“If those goals are clear and the path to soon-to-be-much-higher valuations is clear then it might just be a bump in the road.”
“However, if management and ownership seem to be in over their heads, a down round might mean perception equals reality.”
Stay positive: But Danzig suggests positivity can win the day. “While a down round can be perceived negatively, it’s not by any means a death knell,” says Danzig. “Many companies can and do adjust successfully after a down round, using the funds to recalibrate and forge a stronger path forward.”
“Down rounds can definitely be overcome,” says Wachtel.
“My experience in the industry is only as old as Huddle and so this market correction is my first in the industry,” he adds.
“But FanDuel and DraftKings come to mind as two companies who went through tough times due to regulatory challenges in 2015 but then have risen like phoenixes from the ashes.”
“The path forward to a meaningful ROI becomes more difficult on the heels of a down round but just as market dynamics send valuations down, a change in valuation could have those same company valuations headed north again,” says Cherniak.
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Growth company gazette
Woof: In an interview with E+M on the launch of an initiative to find startups with original ideas around responsible gambling, Underdog Fantasy CEO Jeremy Levine made the understated point that his company is “definitely talking to a lot of regulators”.
The GuardDog initiative has seen Underdog Fantasy backstop an effort to accelerate early-stage startups with $1m in initial funding.
The aim is to identify and provide support to companies “building new and creative solutions to address problem gaming and further responsible gaming”.
Companies and entrepreneurs interested in being considered by GuardDog can learn more and contact the GuardDog team at https://underdogfantasy.com/guarddog.
It’s twins! Miami-based AI sports predictive platform provider Gemini Sports Analytics has completed an oversubscribed $3.25m seed round led by Roger Ehrenberg’s Eberg Capital and with the participation of Social Leverage, Raptor Group and Florida Funders.
BroThrow has beef: The social sports-betting startup is – quietly – kicking up a stink over what appears to be the clear similarities of its logo and that of the soon-to-launched ESPN Bet. Not only is there the emphasis on the stylized B, but also the choice of color.
The month in focuses
Machine learning-assisted provider Golden Whale.
Sports betting API provider SharpSports.
Fantasy sports innovator Units.
Irish B2C sports-betting operator We The Bookie.
Calendar
Nov 7: Melco Resorts, Red Rock Resorts, AGS
Nov 8: GiG, Everi, Full House, MGM Resorts, Accel
Nov 9: Flutter, Light & Wonder, Bragg, Super Group, Wynn, Century
An +More Media publication.
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