AI Startups' Dual-Priced Equity: What's the Catch?

Amidst escalating competition among AI startups, founders and venture capitalists are increasingly employing innovative valuation mechanisms to cultivate an impression of market leadership.

Historically, highly sought-after companies typically secured multiple funding rounds in rapid succession, each at an incrementally higher valuation. However, recognizing that constant fundraising diverts founders from core product development, leading VCs have engineered a new pricing structure that effectively merges what would traditionally be two distinct funding cycles into a single event.

Notable recent rounds utilizing this strategy include Aaru’s Series A. The synthetic-customer research startup raised capital in a round led by Redpoint, which invested a substantial portion of its funding at a $450 million valuation, as reported by The Wall Street Journal. Redpoint then allocated a smaller investment at a $1 billion valuation, a price point at which other VCs subsequently participated, according to our reporting. TechCrunch was the first to detail Aaru’s financing, including its multi-tiered valuation.

This approach allows desirable startups like Aaru to claim "unicorn" status — a valuation exceeding $1 billion — even though a significant segment of their equity was acquired at a lower price point.

“It is a sign that the market is incredibly competitive for venture capital firms to win deals,” stated Jason Shuman, a general partner at Primary Ventures. He added, “If the headline number is huge, it’s also an incredible strategy to scare away other VCs from backing the number two and number three players.”

Such a massive ‘headline’ valuation effectively projects an aura of being a market winner, despite the lead VC’s average investment price being considerably lower.

Multiple investors conveyed to TechCrunch that, until recently, they had never encountered a deal where a lead investor divided their capital across two different valuation tiers within a single funding round.

Wesley Chan, co-founder and managing partner at FPV Ventures, views this valuation tactic as symptomatic of bubble-like market behavior. He remarked, “You can’t sell the same product at two different prices. Only airlines can get away with this.”

In most scenarios, founders offer a discount to top-tier VCs because their involvement acts as a powerful market signal, instrumental in attracting talent and future capital.

However, as these rounds are frequently oversubscribed, startups have found a way to accommodate the excess interest: instead of turning away eager investors, they allow them to participate immediately, but at a significantly higher price. These investors are willing to pay that premium as it represents their only opportunity to secure a position on a highly sought-after cap table.

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

While an impressive “headline” valuation can certainly aid in recruiting talent and attracting corporate customers who may perceive the company as holding a stronger market position than its competitors, this strategy is not without its inherent risks.

Jason Shuman noted that even though the true, blended valuation for these startups is lower than $1 billion, they are subsequently expected to raise their next round at a valuation surpassing the headline price; failing to do so would result in a punitive down round.

These companies are currently in high demand, but they may encounter unexpected challenges that will make it exceedingly difficult to justify their lofty valuations. In a down round, employees and founders face a reduced ownership percentage of the company; such an event can also erode the confidence of partners, customers, prospective investors, and potential new hires.

Jack Selby, managing director at Thiel Capital and founder of Cooper Sky Capital, cautioned founders against chasing extreme valuations, pointing to the challenging market reset of 2022 as a stark cautionary tale. He concluded, “If you put yourself on this high-wire act, it’s very easy to fall off.”