As competition among AI startups heats up, founders and VCs are turning to novel valuation methods to create a vision of market dominance.
Until recently, in-demand companies have raised multiple rounds of funding in quick succession at increasing amounts. However, because continuous fundraising is distracting founders from building their products, lead VCs have devised a new pricing structure that effectively combines what would otherwise be two separate funding cycles into one.
Recent rounds using this program include Aaru’s Series A. The synthetic-customer research startup raised a round led by Redpoint, which invested most of its check in an estimated $450 million, the Wall Street Journal reported. Redpoint then invested a small portion at a valuation of $1 billion, and other VCs joined at that same price point of $1 billion, according to our report. TechCrunch was the first to report on Aaru’s financials, including its multi-tiered analysis.
This method allows ambitious startups like Aaru to call themselves a unicorn – valued at more than $1 billion – even though most of the equity was acquired at a low price.
“It’s a sign that the market is incredibly competitive for real estate firms to win deals,” said Jason Shuman, general partner at Primary Ventures. “If the title number is big, it’s also a great strategy to scare other VCs into backing the number two and three players.”
A large valuation of the “headline” creates an aura of a winner in the market, even if the average value of the leading VC was very low.
Many investors told TechCrunch that until recently, they had never come across a deal where a lead investor splits his money between two different tiers of valuation in one round.
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Wesley Chan, founder and managing partner at FPV Ventures, views this valuation strategy as a sign of bubble-like behavior. “You cannot sell the same product at two different prices. Only airlines can handle this,” he said.
In many cases, founders offer a discount to top VCs because their involvement serves as a powerful market signal that helps attract talent and future capital.
But since these rounds are often oversubscribed, startups have found a way to deal with excessive interest: Rather than chase away willing investors, they let them participate quickly, but at a much higher price. These investors are willing to pay that premium because it’s the only way to secure a spot at the much-needed table.
Another startup that has offered special pricing to lead investors is Serval, an AI-powered IT help desk startup, according to the Wall Street Journal. Although Sequoia’s lowest entry price was $400 million, Serval announced in December that its $75 million Sequoia valued the company at $1 billion.
While a high “headline” rating can help attract talent and attract corporate customers who may view the company as having a stronger market position than its competitors, the strategy has its risks.
Even if the true, combined valuation of these startups is less than $1 billion, they are expected to raise their next round at an amount higher than the title price; otherwise it will be a round of punishment, said Shuman.
These companies are in high demand now, but they may face unexpected challenges that will make it more difficult for them to justify their high valuations. In the lower tier, employees and founders end up with a small percentage of ownership of the company; and they can destroy the confidence of partners, customers, future investors, and new employment opportunities.
Jack Selby, managing director at Thiel Capital and founder of Copper Sky Capital, warns investors that chasing valuations too much is a dangerous game, pointing to the painful market reset of 2022 as a warning. “If you put yourself in this high-wire act, it’s very easy to fall,” he said.
