A startup guide to priced and unpriced funding rounds for startups
A startup guide to priced and unpriced funding rounds for startups
Figure out the differences between priced and unpriced funding rounds, and how they impact your startup's valuation, equity dilution, and fundraising
When it comes to raising capital, a startup has to decide if the funding round is going to be a priced or unpriced round. The choice between these two funding structures can have significant implications on your startup’s valuation, future fundraising outlook and options, and overall equity dilution.
In this article, we will look at the differences between priced and unpriced rounds, providing insights from the perspective of a venture lawyer.
This table summarises the key differences between priced and unpriced rounds when it comes to capital raising for startups.
Priced rounds
In a priced round, the investor and the startup agree on a specific valuation for the company. This valuation is used to determine the price per share, which in turn determines the amount of equity the investor will receive in exchange for their investment.
Priced rounds are often favoured by investors who want certainty on their ownership stake in the company and are comfortable with the fixed valuation.
Here are several key features when it comes to priced rounds:
Clear valuation: The valuation is agreed upfront, providing both the startup and the investor with a definitive benchmark.
Equity ownership: Investors receive a specific percentage of the company’s equity based on the agreed valuation in exchange of the investment amount received by the company.
Future fundraising: Priced rounds may likely be easier for startups to raise subsequent rounds of funding, as investors may have a reference point when determining a valuation.
Negotiation: The valuation process may involve negotiations between the startup and the investor, which can be time consuming.
Unpriced rounds
In an unpriced round, the valuation of the company is not determined upfront.
Instead, the investors agree to invest a certain amount of money in exchange for convertible notes or warrants. Unpriced round fundraising is typically conducted with convertible notes and ‘Simple Agreement for Future Equity (‘SAFE’).
These instruments are typically convertible into equity at a future date, often when the company raises a subsequent priced round. Unpriced rounds are often used by investors when investing in early-stage startups that may not have a clear or established valuation i.e. like a pre-seed round.
Here are the several key features when it comes to unpriced rounds:
Deferred valuation: The valuation of the company is determined at a later stage, typically when a priced round is raised.
Equity issuance: The investors only receive convertible notes or warrants that can be converted into equity at a future date i.e. when a priced round is raised as defined in the instrument.
Flexibility: Unpriced rounds may provide flexibility for startups that are still developing their business model or may not have a clear valuation.
Potential dilution: Investors in unpriced rounds may face higher dilution risk if the company’s valuation increases significantly before the conversion of their notes or warrants. Similarly, unskilled founders may face significant dilution if they do not take into consideration dilution impacts on the cap table in the following round, resulting in a “dilution waterfall.”
Choosing between priced and unpriced rounds
Deciding whether to pursue a priced or unpriced round depends on various factors and considerations including:
Stage of the startup: Early-stage startups raising a pre-seed or seed round may opt for unpriced rounds to avoid setting a valuation too early.
Investors’ skepticism and preferences: Some investors may prefer priced rounds for clarity and certainty in contrast to unpriced rounds due to the higher dilution risk, uncertainty around ownership or unfavourable conversion terms, while others may be more comfortable with unpriced rounds. In this instance, understanding your investor’s risk appetite will play a role in determining where they will invest and their preferred approach.
Market conditions: The overall market sentiment and investor’s appetite can influence the choice between priced and unpriced rounds.
Final thoughts
Both priced and unpriced rounds have their advantages and disadvantages.
As a founder, deciding on either one will depend on several factors ranging from the startup’s funding stage, investor preferences and market conditions. I hope by understanding the differences between these funding structures, you can make informed decisions about how to raise capital and position your business for future growth. Engaging a venture and startup lawyer can help you navigate the complexities of fundraising and ensure that the funding structure aligns with your objectives.
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A version of this article was originally published on e27.