As competition among AI startups intensifies, founders and venture capitalists are turning to new evaluation mechanisms to create a perception of market advantage.
Until recently, the most popular companies raised multiple rounds of funding in quick succession at increasing valuations. However, continuous funding distracts founders from product development, so the lead VC devised a new pricing structure that effectively merges what were originally two separate funding cycles into one.
Recent rounds using this scheme include Earl’s Series A. The synthetic customer research startup raised a round led by Redpoint, investing the bulk of the check at a valuation of $450 million, The Wall Street Journal reported. According to our report, Redpoint subsequently invested a smaller amount at a valuation of $1 billion, and other venture capital firms also joined in at the same $1 billion price. TechCrunch first reported Aaru’s funding, which included a multi-tier valuation.
This approach allows desirable startups like Aaru to call themselves unicorns with valuations of more than $1 billion, even if the majority of their shares are acquired at low prices.
“This shows that the market is incredibly competitive for venture capital firms to get deals,” said Jason Schuman, general partner at Primary Ventures. “If the headline numbers are huge, it’s also a great strategy to scare other VCs away from backing the No. 2 or No. 3 players.”
Even though the lead VC’s average price was significantly lower, the huge “headline” valuation gives it the aura of a market winner.
Multiple investors told TechCrunch that until recently, they had never encountered a deal where the lead investor split the capital into two different valuation tiers in one round.
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Wesley Chan, co-founder and managing partner of FPV Ventures, sees this valuation tactic as a sign of bubble-like behavior. “You can’t sell the same product at two different prices. Only airlines can get away with this,” he said.
In most cases, founders will offer discounts to top VCs. This is because their involvement acts as a strong market signal that helps attract talent and future funding.
But these rounds are often oversubscribed, so startups have found ways to deal with the overabundance of interest. Rather than drive away eager investors, it lets them jump in right away, but at a significantly higher price. These investors are willing to pay that premium because it’s the only way to secure a spot on a high-demand cap table.
Another startup that received preferential pricing from its lead investor is Serval, an AI-powered IT help desk startup, according to the Wall Street Journal. Sequoia’s minimum entry price was a $400 million valuation, but Serval announced in December that a $75 million Series B valued the company at $1 billion.
A high “headline” rating helps recruit talent and attract corporate customers who see the company as having a stronger market position than its competitors, but this strategy is not without risks.
The true combined valuation of these startups is less than $1 billion, but they are expected to raise their next round at a higher valuation than their headline price. Otherwise, Schuman said, it would be a punitive down round.
Although these companies are currently in high demand, they may face unforeseen challenges that make it very difficult to justify their high valuations. In a down round, employees and founders reduce their ownership in the company. It can also undermine the trust of partners, customers, future investors, and potential new employees.
Jack Selby, managing director of Teal Capital and founder of Copper Sky Capital, points to 2022’s painful market reset as a lesson, warning founders that chasing extreme valuations is a dangerous game. “When you put yourself in a dangerous situation like this, it’s very easy to fall,” he said.
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