As competition among AI startups intensifies, founders and venture capitalists are adopting novel valuation mechanisms to create a perception of market dominance. Previously, the most sought-after companies would raise multiple funding rounds in quick succession at ever-higher valuations. However, because constant fundraising distracts founders from building their products, lead investors have devised a new pricing structure. This approach effectively consolidates what would have been two separate funding cycles into a single round.
Recent rounds employing this scheme include Aaru’s Series A. The synthetic-customer research startup raised a round led by Redpoint. According to reports, Redpoint invested a large portion of its capital at a $450 million valuation. It then invested a smaller portion at a $1 billion valuation, with other venture capitalists joining at that same $1 billion price point. This multi-tiered valuation strategy allows desirable startups like Aaru to call themselves unicorns, valued at over $1 billion, even though a significant portion of the equity was sold at a lower price.
This tactic is a sign that the market is incredibly competitive for venture capital firms trying to win deals. A massive headline valuation can scare away other investors from backing the number two and number three players in a market. It creates the aura of a market winner, even though the lead investor’s average price per share was significantly lower. Multiple investors have stated that, until recently, they had never encountered a deal where a lead investor splits its capital between two different valuation tiers in a single round.
Wesley Chan, co-founder and managing partner at FPV Ventures, views this valuation tactic as a symptom of bubble-like behavior. He remarked that you cannot sell the same product at two different prices, and that only airlines can get away with such a practice.
Typically, founders offer a discount to top-tier venture capital firms because their involvement serves as a powerful market signal that helps attract talent and future capital. However, since these rounds are frequently oversubscribed, startups have found a way to accommodate excess interest. Rather than turning away eager investors, they allow them to participate immediately, but at a significantly higher price. These investors are willing to pay that premium because it is the only way to secure a spot on a high-demand cap table.
Another startup that used this preferential pricing for its lead investor is Serval, an AI-powered IT help desk startup. While Sequoia’s lowest entry price was at a $400 million valuation, Serval announced a $75 million Series B that valued the company at $1 billion.
While a high headline valuation can help recruit talent and attract corporate customers who may view the company as a market leader, the strategy carries risks. Even though the true, blended valuation for these startups is lower than $1 billion, they are expected to raise their next round at a valuation higher than the headline price. Otherwise, it would be considered a punitive down round. These companies are in high demand now, but they may face unexpected challenges that make it difficult to justify their high valuations. In a down round, employees and founders end up with a smaller ownership percentage. It can also erode the confidence of partners, customers, future investors, and potential new hires.
Jack Selby, managing director at Thiel Capital and founder of Cooper Sky Capital, warns founders that chasing extreme valuations is a dangerous game. He points to the painful market reset of 2022 as a cautionary tale, stating that if you put yourself on this high-wire act, it is very easy to fall off.