Why do AI startups sell the same stock at two different prices?

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 hottest companies raised multiple rounds of funding in quick succession and at spiraling valuations. However, because constant fundraising distracts founders from building their products, leading VC firms have devised a new pricing structure that effectively merges what would have been two separate funding cycles into one.

Recent rounds using this scheme include Aaru’s Series A. The synthetic customer research startup has raised a round led by Redpoint, which invested a significant portion 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 VC firms joined in at the same $1 billion price point, according to our reporting. TechCrunch was first to report on Aaru’s funding, including its multi-tier evaluation.

This approach allows coveted startups like Aaru to call themselves a “unicorn” — valued at more than $1 billion — despite acquiring a significant chunk of stock 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 headline number is huge, it’s also an amazing strategy to scare other VCs out of backing the number two and number three players.”

The huge “prime” valuation creates the aura of a winner in the market, even though the average price of the prime VC was much lower.

Several investors told TechCrunch that, until recently, they had never encountered a deal in which a lead investor would split their capital between two different valuation levels in a single 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 a discount to top-tier venture capital firms because their participation serves as a strong market signal that helps attract future talent and capital.

But since these rounds are often oversubscribed, startups have found a way to absorb the excess interest: Instead of turning away eager investors, they allow them to participate immediately, but at a much higher price. These investors are willing to pay this premium because it is the only way to secure a place at the high demand cap table.

Another startup that gave preferential pricing to its lead investor is Serval, an AI 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 “key” 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 true hybrid valuation of these startups is less than $1 billion, they are expected to raise their next round at a valuation above the headline price; Otherwise, it will be a punishment 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 down round, employees and founders end up with a lower percentage of ownership in the company; They can also erode the trust of partners, customers, future investors and potential new employees.

Jack Selby, managing director at Thiel Capital and founder of Cooper Sky Capital, warns founders that chasing extreme valuations is a dangerous game, pointing to the painful market reset in 2022 as a cautionary tale. “If you put yourself in this dangerous job, it’s very easy to fall,” he said.