Meaning
Capital acquisition events occasionally trigger a drastic reduction in the ownership percentage of existing stakeholders. Investment round that significantly dilutes the ownership of existing shareholders, often at a valuation substantially lower than previous rounds. A washout financing often happens when a business is running out of cash and has no other options.
The result is a clean slate for the capitalization table.
Valuation Pressure
Market conditions or poor performance force the company to take capital at a steep discount. In a washout financing, the price per share is a fraction of what was paid in earlier rounds. This wipes out the gains of the early backers.
Ownership Erasure
Founders may see their stake drop from a large percentage to nearly zero in a single transaction. Because the new money is necessary for survival, the existing shareholders have little power to stop the washout financing from happening. This often leads to the replacement of the board.
It also triggers the creation of new incentive plans. Such plans are needed to keep the employees from quitting.
Governance Shift
Power moves from the founders to the new investors who provided the emergency capital. The new owners typically take control of the board seats. This changes the direction of the company.
