Wash-Out Round: What It Means and How It Works

A wash-out round (also called a burn-out round or cram-down deal) is a financing event in which new investors purchase equity on terms that drastically dilute existing shareholders, allowing the newcomers to seize control of the company. These rounds typically occur as emergency, last-resort financings for struggling startups or small companies that need capital to avoid bankruptcy.

Key points

• New investors buy equity at a deeply discounted price or on terms that produce a dominant ownership stake.
• Existing shareholders and earlier investors often see their ownership and voting power reduced to near zero.
• Wash-out rounds are usually a last resort to stave off bankruptcy or liquidation.
• Management is often replaced or substantially subordinated, though some prior executives may be retained for continuity or brand reasons.

How a wash-out round works

A wash-out round is structured to favor incoming capital. Typical features include low share pricing, issuance of a large number of new shares, special senior or control-preference rights for new investors, or conversion features that subordinate earlier classes of stock. Because the new issuance so dramatically increases the company’s outstanding shares, prior owners’ percentage ownership and economic and voting interests are severely diluted.

Investors agree to such terms when they believe the company’s assets, intellectual property, customer base, or other elements can be monetized or turned around under new leadership. For the company, accepting a wash-out is often the only alternative to bankruptcy or winding down operations.

When wash-outs happen

Wash-out rounds most often occur when:
* A company repeatedly fails to meet performance milestones required for follow-on financing.
* Core products or services fail to achieve necessary market traction.
* Regulatory setbacks or other catastrophic events destroy near-term commercial prospects.
* There are no other financing sources willing to invest on less onerous terms.

Historic examples include episodes during the dot-com era when many overvalued firms later sought emergency capital on dilutive terms.

Effects on ownership and management

• Shareholders: Prior investors and founders can lose voting control and see the value of their holdings significantly reduced. In many cases prior preferred stock protections are restructured or rendered ineffective by the new terms.
• Management: New owners often replace existing leadership to implement a turnaround plan or to prepare assets for sale. Some members of prior management may be retained if continuity benefits the new owners.
• Strategy: New investors may prioritize extracting value from assets (IP, product lines, customer data) rather than preserving the company’s original operating plan.

Implications and considerations

• For founders and early investors: Negotiating anti-dilution provisions, protective covenants, board representation, and preemptive rights can reduce the risk of a full wash-out, but these protections may be limited in extreme distress.
• For prospective new investors: A wash-out can provide control and the chance to realize value, but it also carries the risk that the underlying business cannot be salvaged.
• For the company: A wash-out is often a last-chance option; accepting it trades control for liquidity and a chance at survival or asset recovery.

Conclusion

A wash-out round shifts control and value to new capital providers by issuing equity on heavily dilutive or senior terms. While it can rescue a failing company from immediate collapse, it typically destroys the economic and governance positions of prior owners and often leads to leadership and strategic changes aimed at salvaging value.