The Firstbase guide to priced and unpriced financing rounds
As an ambitious startup founder, you’re well aware of the critical role that funding plays in accelerating your business to success. However, the journey to secure the right financing can be intimidating, with unpriced and priced options and unique strategies to consider.
This blog will highlight the differences between unpriced and priced financing rounds. By the end, you’ll know how to make informed decisions that perfectly align with your startup’s needs and goals.
Unpriced financing rounds
Startups often use convertible notes and/or SAFEs (Simple Agreements for Future Equity) to raise money in the early stages. These are unpriced financing methods, which means they avoid the need to negotiate the company’s valuation.
Bypassing negotiating the company’s valuation is helpful, especially for the earliest-stage startups where determining a fair valuation may be challenging.
Convertible notes are another form of unpriced financing often used by new startups. They are a form of short-term debt. Later converted into equity during a future priced funding round, they also feature a maturity date and interest rate.
Unlike convertible notes, SAFEs are not regarded as debt and do not accumulate interest over time.
Let’s explore why unpriced financing rounds might be advantageous for your business:
In the early stages, when valuations may be uncertain, unpriced rounds offer a quicker and simpler way to secure funding. Convertible notes are faster and cheaper to issue because they usually need fewer negotiations.
Unpriced rounds defer the valuation until the next priced round. They allow founders and investors to postpone possibly tricky and tough conversations around the startup’s valuation. This gives you more time to increase your startup’s value.
If the company is dissolved, convertible note holders usually get paid back before equity shareholders, offering them financial protection.
Incentive for additional financing
SAFEs provide incentives for the interested parties to look for additional financing. The terms of SAFEs usually become more favorable with additional financing rounds.
Provisions can include valuation caps or discounts on the price per share during future equity financing. These terms are designed to reward early investors for their initial support and risk, usually resulting in them getting a larger ownership stake in the company if it secures added financing.
Priced financing rounds
Priced financing rounds, often seen in later stages of growth, involve issuing shares of your company to investors at a predetermined price.
Here’s why priced financing rounds might be the right path for your venture:
With priced rounds, you establish a clear valuation for your startup. This transparency benefits investors and founders, offering a solid foundation for the funding process.
Fixed share prices allow you to maintain control over dilution as more investors join your journey. This management level safeguards your ownership stake, ensuring your vision remains intact.
Priced rounds tend to attract institutional investors who appreciate the defined valuation, making them more willing to invest significant amounts.
An ongoing concern among startup founders during the investment process is the risk of ownership dilution. With priced financing rounds, dilution can be managed effectively, thanks to the predetermined share prices.
However, unpriced rounds may result in unexpected dilution once the round is priced eventually. This could affect your control over your own venture. Understanding these intricacies between priced and unpriced rounds is essential. Sustain your ownership stake and keep your startup vision intact.
Deciding on priced vs. unpriced financing
The right funding approach ultimately depends on your preferences and the unique circumstances of your business. These considerations will help you make a more informed decision for your startup.
A priced financing round comes with its share of legal obligations that startups must comply with. You will need to file with the SEC, secure a 409A valuation, and issue preferred shares, among other necessary steps.
Filing with the SEC involves submitting documents to the Securities and Exchange Commission (SEC) to meet regulatory requirements when issuing securities, such as selling shares to raise capital.
A 409A valuation is an independent appraisal of the fair market value of your startup’s common stock. It is necessary to establish the proper strike price for employee stock options, which is legally required under Section 409A of the US Internal Revenue Code.
When raising capital, startups generally issue preferred shares to investors. These shares have special rights and privileges, such as priority in receiving dividends and liquidation preferences, which make them more appealing to investors.
These prerequisites are part of the systematic foundation to ensure legality and success in your priced round. Carefully following these mandatory legal processes can create a smoother way forward for your startup’s funding journey.
As you evaluate the financing options for your startup, keep these factors in mind:
The funding stage refers to the phase in a startup’s life cycle in which it is seeking or receiving financial investment. Different funding stages often need different funding strategies.
The two main strategies include unpriced and priced rounds.
During unpriced rounds, investors provide capital in exchange for a convertible note or a SAFE (Simple Agreement for Future Equity). These types of financings do not establish a formal valuation for the company.
They are commonly used in the “seed” or very early stages of a startup when the company’s potential value is still unclear, and the main goal is to raise initial capital to build the startup.
The company’s value is explicitly determined with priced rounds, and investors purchase equity shares at a specific price. These rounds usually happen when the startup is more established and can provide investors with financials, user data, growth metrics, or other evidence to justify the valuation.
Consider the type of investors you want to attract. Priced rounds may draw institutional investors, while unpriced rounds appeal to angel investors and seed-stage VCs.
Reflect on your startup’s needs, growth trajectory, and investor preferences to determine your business’s most suitable financing option.
Understanding the distinctions between priced and unpriced financing rounds is essential as you secure funding for your startup.
With clear valuations and dilution control, priced rounds fit well with more established companies. On the other hand, unpriced rounds offer flexibility and simplicity in the early stages.
If you’re serious about acquiring funding, you’ll need to incorporate a C-corp in order to issue equity to investors. Click below to start your incorporation with Firstbase today.