Why AI startups are selling the same equity at two different prices

As competition among AI startups increases, founders and venture capital funds are turning to new valuation mechanisms to create a perception of market dominance.

Until recently, the most sought-after companies raised multiple rounds of financing in quick succession at rising valuations. However, as constant fundraising distracts founders from building their products, leading VCs have devised a new pricing structure that effectively consolidates two separate funding cycles into one.

Recent rounds using this plan include Aaru’s Series A. The synthetic customer research startup raised a round led by Redpoint, which invested a large chunk of its check at a $450 million valuation. This is reported by the Wall Street Journal. Redpoint then invested a smaller portion at a $1 billion valuation, and other VCs joined at the same $1 billion price point, according to our reporting. TechCrunch was the first to report Aaru’s funding, including its multi-tiered valuation.

This approach allows desirable startups like Aaru to call themselves a unicorn – valued at over $1 billion – even though a significant portion of the equity has been acquired at a lower price.

“It’s a sign that the market is incredibly competitive for venture capital firms to land deals,” said Jason Shuman, general partner at Primary Ventures. “If the top number is huge, it’s also an incredible strategy to keep other VCs from backing the numbers two and three.”

The huge “headline” valuation creates the aura of a market winner, even though the average price of the leading VC was significantly lower.

Multiple investors told TechCrunch that until recently, they had never come across a deal where a lead investor split their capital between two different valuation levels in one round.

Wesley Chan, co-founder and managing partner at FPV Ventures, sees this valuation tactic as a symptom 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 offer discounts to top tier venture capital funds because their involvement serves as a powerful market signal that helps attract talent and future capital.

But because these rounds are often oversubscribed, startups have found a way to accommodate the excess interest: instead of turning away eager investors, they offer them the opportunity to participate immediately, 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 an in-demand cap table.

Another startup that gave preferential pricing to its lead investor is Serval, an AI-powered IT helpdesk startup, according to The Wall Street Journal. While Sequoia’s lowest entry price was a $400 million valuation, Serval announced in December that Sequoia’s $75 million Series B valued the company at $1 billion.

While the high ‘headline’ valuation can help recruit talent and attract corporate clients who may view the company as having a stronger market position than its competitors, the strategy is not without risks.

Although the real blended valuation for these startups is below $1 billion, they are expected to raise their next round at a valuation higher than the nominal price; otherwise it will be a penalty round, Shuman said.

These companies are currently in high demand, but they may face unexpected challenges that make it very difficult for them to justify their high valuations. In a down round, employees and founders receive a smaller ownership percentage of the company; they can also erode the confidence of partners, customers, future investors and potential new employees.

Jack Selby, managing director at Thiel Capital and founder of Copper Sky Capital, warns founders that chasing extreme valuations is a dangerous game, pointing to 2022’s painful market reset as a cautionary tale. “When you put yourself on this kind of tightrope walk, it’s very easy to fall off,” he said.