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Party rounds have been a controversial topic in the venture industry, but the economic downturn will likely limit their use.  

In the last decade, the average number of investors per round had been increasing steadily, reaching a peak in 2021 at 5.84 per deal, according to PitchBook data. At the same time, party rounds—deals in which smaller amounts of capital are raised from multiple investors in the double digits with no lead—also grew in number.

"I think that party rounds are a uniquely bull market phenomenon," said Hari Raghavan, CEO of AbstractOps, which raised a party round in 2021. "The low interest rate environment opened up new ways for startups to raise funding, and the amount of capital in the market made it easier."

The recent bull market offered ideal conditions for party rounds, according to Raghavan. With multiple firms vying for the same opportunities, founders could take advantage of outsized demand by accepting a larger number of checks.

For founders, party rounds could allow them to keep more control over the direction of their startup, as none of their investors have a large share in their business or board seat. And with more investors, there are more avenues for networking and advice.

But with the downturn, the average number of investors has now fallen to 3.53—the lowest in over a decade. And at the same time, the number of rounds with a large quantity of backers has also been declining since the onset of the downturn.  
The main criticism of party rounds, according to VSC Ventures general partner Jay Kapoor, has been the lack of "skin in the game." In the absence of a lead investor, it can be challenging to hold any single investor accountable for their commitments or contributions to a startup's success.

"A party round is one where everybody likes your company, but nobody loves it," Kapoor said. "You can't expect loyalty or much assistance from your investors because they've likely got much less capital invested in you than their other portfolio companies."

If things start to go poorly for a business, the argument goes that no single firm has the incentive to take responsibility for guiding the company's strategy. Decision-making can become fragmented and less efficient as a result of the more complex cap table. 

Having supportive and invested backers is particularly important in the current market with the present economic volatility, falling valuations and a tighter funding environment. 

"I think we'll see less [party rounds] overall," said Leila Zegna, founding partner of Kindred Capital. "In this market, VCs are focusing on ownership, and founders really care about value-added investors. An investor who isn't engaged and is just providing capital—that really hurts right now."

While overall party rounds are expected to be less popular in the current market, Zegna believes there may be exceptions with what she describes as "learning checks." Areas such as generative AI, which shows signs of the hype seen in 2021, could be targets for party rounds as investors seek to put in small checks in order to gain more knowledge about the industry and affiliation to the current hottest trend.

Kapoor believes that we may see party rounds persist for startups that need capital but are struggling to raise it.

"Party rounds for companies that are scrounging dollars to keep themselves afloat will continue to happen, but it's taking on risk," Kapoor said. "If nobody is willing to lead your round, then that says something about you. Achieving that short-term goal of getting money is delaying the inevitable. And at some point, the lack of accountability from your cap table will bite you."

Featured image by SEAN GLADWELL/Getty Images

This article originally appeared on PitchBook News