A Founder’s Toolkit: Priced vs. Non-Priced Rounds in Venture Capital Financings

One key distinction founders often encounter early on is the difference between a priced round and a non-priced round. This article aims to demystify these two approaches, highlighting their respective pros and cons and the types of securities typically issued.

Priced Rounds

A priced round involves the sale of equity at a predetermined valuation. Investors purchase shares at a specific price per share, based on a mutually agreed valuation of the company. This valuation typically sets the company’s post-money and pre-money valuations, clearly indicating how much ownership the founders, existing holders and new investors will have after the transaction.

Securities Issued

In priced rounds, the common securities issued include preferred shares. These shares generally come with certain rights and preferences, such as dividend rights, liquidation preferences, anti-dilution provisions and participation rights. These provisions are commonly carefully negotiated between the investors and the company.

Pros

1. Clear Valuation: A priced round provides transparency about the company’s valuation, helping align expectations between the company and investors.
2. Credibility: While not exclusively confined to priced rounds, successfully closing a priced round with a reputable lead investor can enhance a company’s credibility and signal maturity to future investors.
3. Governance: Priced rounds often result in more structured governance practices, with investors negotiating board seats or other oversight mechanisms. While founders might initially perceive this as a drawback, it frequently helps them transition from the ‘startup’ phase to a more mature company trajectory.

Cons

1. Lengthy Negotiation Process: Negotiating valuation, rights and preferences can be time-consuming, delaying the closing process and increasing upfront costs.
2. Dilution: Founders and early investors may experience significant dilution due to predetermined valuations picked during a company’s infancy.
3. Rigid Structure: The terms and conditions of priced rounds can limit flexibility for future funding strategies. What you agree to now will set a precedent for future rounds, even in rounds where leverage favors the founders.

Non-Priced Rounds

Non-priced rounds, such as convertible notes or Simple Agreements for Future Equity (SAFEs), do not set a specific valuation. Instead, they offer investors securities that convert into equity upon a triggering event, like a subsequent priced round. The conversion price is often tied to a discount and/or valuation cap, giving early investors favorable terms when their investment converts.

Securities Issued

1. Convertible Notes: A debt instrument that converts into equity based on pre-negotiated terms. Typically, the note will convert at a discount to the next round’s valuation and/or have a valuation cap.
2. SAFEs: An equity-like agreement where the investment amount converts into equity at a discount and/or valuation cap when a priced round occurs.

Pros

1. Speed and Simplicity: Non-priced rounds are often faster to close and involve less negotiation around valuation and terms.
2. Cost-Effective: Reduced legal and administrative expenses can make non-priced rounds more cost-effective for startups.
3. Founder-Friendly: Founders can raise funds without immediately locking in a valuation, allowing time for their companies to mature.
4. Flexibility: The conversion structure provides flexibility, as the terms adapt to future valuation developments.

Cons

1. Uncertain Valuation: Lack of a clear valuation can create uncertainty for both founders and investors regarding ownership percentages post-conversion.
2. Investor Skepticism: While not as common among experienced venture investors, some angels or institutional investors may be less inclined to invest in non-priced rounds due to potential dilution, uncertainty around ownership, or unfavorable conversion terms.
3. Potential Conflicts: Conversion terms, especially valuation caps and discounts, can lead to conflicts between founders and investors when negotiating subsequent financing rounds.

Which is Right for Your Company?

Choosing between a priced or non-priced round often depends on the company’s growth stage, immediate funding needs and investor relationships.

• Early-Stage Companies: Founders often lean towards non-priced rounds to secure seed funding quickly and avoid premature valuation setting.
• Mid-Stage or Growth-Stage Companies: Priced rounds become more suitable as companies establish market traction, mature their business models and gain negotiating leverage. A priced round can attract institutional investors who prefer structured ownership rights.

Conclusion

Both priced and non-priced rounds are powerful tools in venture capital financing. Founders must weigh the pros and cons of each to align with their growth objectives and investor expectations. By understanding the securities involved and the strategic implications of each approach, founders can confidently navigate their financing journey, ensuring their startup is well-positioned for future growth.

Our firm is prepared to guide you through this process, providing expert advice tailored to your unique needs. Reach out today and let us help you propel your startup toward success.

Author Jason Acevedo is a partner in the Venture Capital & Emerging Growth practice group in the Corporate and Securities Department at Klehr Harrison.

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