With so many startups raising money at huge valuations, there’s a real risk that some won’t be able to meet expectations and grow into their valuation. As an entrepreneur leading a startup that doesn’t meet the goals to raise money at increasingly larger valuations, there are essentially two options: raise money at a lower valuation (down round) or let employees go to get to breakeven (assuming a fair amount of revenue).

Here are some challenges of a down round:

• Common shareholders often get wiped out depending on anti-dilution rights for the preferred investors
• Employees’ options are typically worthless providing less financial incentive to stay
• Morale suffers and good people leave
• Earlier investors are unhappy as their mark-to-market paper returns are negatively impacted

Here are some challenges of layoffs:

• Trust with the senior leadership is hurt
• Morale plummets and good people leave
• Employees are constantly worried that more layoffs will happen in the future
• Competitors use the layoffs as FUD when trying to win competitive deals

Neither a down round or layoffs (or both!) is ideal, but it happens more often than discussed. As more startups raise money at very forward-looking valuations, look for more of these challenges to occur.

What else? What are some more challenges associated with a down round or layoffs?