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The Erosion Of “Same Round, Same Price”

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Reading the comments on my recent TechCrunch post, it seems most founders believe investors asking for “extras” on the side are simply greedy and short-sighted.

While it’s easy to criticize investors, I believe this behavior is driven in large part as a response to conditions founders have created in early stage investing. Anecdotally, I believe the following two trends, when taken together, have eroded the “one round, one price” standard.

“Institutional Advisors”

It’s common for founders to provide stock options to relevant advisors for value-added services, and also to join accelerators in their earliest stages in exchange for common shares. Recently, though, there’s been a rise in what I call “institutional advisors” who combine the two models.

By positioning themselves as post-seed accelerators, offering a structured value-add program and some capital to more mature early stage companies, these groups have been able to get more significant option grants than your average advisor — often times in the 2-6 percent range.

When founders bring these groups in after having previously raised a priced round, they are in essence signaling that value add can be separated from money, and are offering these groups a lower price per share than others who may have packaged the two together.

Rolling Valuations

As average valuations for seed stage software companies in the U.S. grew by 71 percent from 2010 to 2014, founders have become comfortable leading their own rounds. The rounds often are priced by angels that are less sensitive to valuation than VCs, and include high-priced convertible notes that close on a rolling basis, with terms that vary per investor.

In late-stage investing, the reaction of many investors to high valuations has always been “name your price and I’ll name the terms,” and this mentality is seeping into early stage investing.

The Erosion Of “One Price, One Round”

As hands-on early stage investors begin to see “institutional advisors” getting significant equity for services (which they likely consider themselves to be providing, as well), and also see founders raising high-priced, rolling valuation convertible notes, I believe this environment has eroded the “one price, one round” standard.

By taking options or warrants for value-added services, investors and advisors in essence negotiate the “right price” for themselves while enabling the founder to keep the higher valuation they wanted for everyone else. The losers, in the end, are co-investors who don’t ask for extras, and the misalignment this practice creates can lead to issues down the line.

My View On Extras

This is a business where one great investment can drive the returns for an entire fund. Most of our best deal flow comes from people with whom we’ve worked in the past, especially as co-investors and founders, and I’d rather optimize for being the best partner I can be to them instead of getting an extra few percent points here and there.

However, while it’s clear to me that “value-added” services should be included with investment, the picture gets fuzzier when extras are used to incentivize investment and involvement in companies that are perceived as overly priced.

A Slippery Slope

Historically, companies that raised internal extension rounds sometimes issued warrants or options to investors in order to maintain investment valuations and incentivize participation. This same practice may make sense in cases where new money and “value add” are coming from outside investors and advisors who perceive the demanded valuation to be too high to justify their involvement.

On the other hand, this can be a slippery slope. Every time founders give these extras to some and not others, they further erode the culture of reciprocity that’s made the startup community one of open value exchange that benefits everyone.

Featured Image: Fedorov Oleksiy/Shutterstock