Sometimes there are bumps along the road in the path to becoming a successful company. One of those bumps could be the change in stock price, even as a private company. When you’re going out to raise one round of capital, you might find that the next valuation is down from your previous one. In other words, you have the down round.

Usually, down rounds are caused by one or two situations or both:

1. Company circumstances have changed and the company has not delivered like they thought they would. They’ve had to pull back and retrench before going forward.

2. The early rounds were overvalued. This can often happen with shifts from going from an individual investor, such as friends and family or angels, to more professional investors, such as a private equity firm.

There could be one option though to the down round and this would be to keep the valuation up, but make it subject to hitting certain targets down the road. If the targets are not hit, then the investors in this new round get to exercise warrants or get certain options, so that their shares percentage jumps up and the valuation changes to what it would’ve been had there been a down round in the first place.

In a way, think of it like the reverse options. Instead of management in essence picking up more options over time, they’re actually picking up less option in a way and end up with less ownership rather than more.

I saw one client who had a situation just like that. The private equity firm knew that the valuation was going to be a hot button for the management. They knew that management had not met the numbers in a major new customer launch, moving from commercial accounts to a big box retail account. So, the company valuation was less than what it would’ve been with the previous round.

However, the private equity firm came up with this approach. They actually stepped up the valuation to a higher level, but put in the provisions that if certain targets weren’t met within a few years period of time that they, the private equity firm, would get a much greater share of the ownership.

The psychology on this, I thought, was brilliant. It played to management egos, but also made them accountable. It kept management feeling good about the valuation used for this round of investment. However, it also made management accountable, so that if they didn’t hit the targets the value would in essence go down quite a bit, but it was on management’s shoulders. They would have no one to blame but themselves. They couldn’t say it was the big private equity firm and their young MBAs coming in and beating down the value.

So, if you face a situation where there might be a down round or you think there might be some gap between what you think it is worth and what the investors think it is worth, consider using this approach. Keep the valuation high, but give the investors incentive to have more shares if you don’t reach your targets. If you’re confident about the expectation for the company and your ability to deliver, this is a great way to stand up and put your equity where you mouth is.