As competition among AI startups heats up, founders and VCs are turning to new valuation mechanisms to create a perception of market dominance.
Until recently, the most sought-after companies raised multiple rounds of funding in succession at escalating valuations. But because constant fundraising distracts founders from building their products, VC leaders have devised a new pricing structure that effectively consolidates what would have been two separate funding rounds into one.
Recent rounds using this format include Aaru’s Series A. The synthetic customer research startup raised a round led by Redpoint, which invested much of its check at a $450 million valuation. the Wall Street Journal reported. Redpoint then invested a smaller portion at a $1 billion valuation, and other VCs joined in at the same $1 billion price, according to our reports. TechCrunch was the first to report on Aaru’s funding, including its tiered valuation.
The approach allows desirable startups like Aaru to call themselves a unicorn — valued at more than $1 billion — even though a significant portion of the equity was acquired at a lower price.
“It’s a sign that the market is incredibly competitive for venture capital firms to win deals,” said Jason Shuman, general partner at Primary Ventures. “If the number of headlines is huge, it’s also an incredible strategy to scare other VCs away from backing the number two and number three players.”
The huge “headline” valuation creates the aura of a market winner, even though the average price of the main VC was significantly lower.
Multiple investors told TechCrunch that until recently, they had never come across a deal where a lead investor splits their capital at two different valuation levels in a single round.
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Wesley Chan, co-founder and managing partner of 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 the airlines can get away with it,” he said.
In most cases, founders offer a discount to top VCs because their involvement serves as a strong market signal that helps attract talent and future capital.
But since these rounds are often oversubscribed, startups have found a way to accommodate the excess interest: instead of turning away willing investors, they let them in right away, but at a significantly higher price. These investors are willing to pay this premium because it is the only way to secure a seat at a highly sought-after table.
Another startup that gave its lead investor preferential pricing is Serval, an artificial intelligence 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 a 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 actual, gross valuation for these startups is less than $1 billion, they are expected to raise their next round at a valuation that is higher than the initial price. Otherwise it will be a punishing round, Schumann said.
These companies are in high demand now, but they may face unexpected challenges that will make it very difficult for them to justify their high valuations. In a downturn, employees and founders end up with a smaller percentage of ownership of the company. They can also erode the trust of partners, customers, future investors and potential new hires.
Jack Selby, managing director of Thiel Capital and founder of Cooper Sky Capital, warns founders that chasing extreme valuations is a dangerous game, pointing to the painful market reset of 2022 as a cautionary tale. “If you put yourself on that radio, it’s very easy to fall,” he said.
