Startup and video game law, from a Canadian and U.S. perspective
As part of our day-to-day practice, we advise clients on different structures available for early-stage financing rounds. As part of these discussions, convertible notes and SAFEs are inevitably raised by the founder yet the concept of a priced round is rarely raised and sometimes not even understood by the founder. Priced rounds were the common approach to financing startups at all stages for over 25 years and are slowly making a comeback, which should be to the benefit of founders.
Understanding the Priced Round. Priced rounds are simple: the company and investors agree to a company valuation and the investors purchase shares in the company at this valuation. Conversely, convertible notes and SAFEs are premised on the parties NOT agreeing to a company valuation, which is answered at a later date when a priced round occurs (typically the series A round) and the convertible notes or SAFEs convert.
When are Rounds Priced? These days, priced rounds first arise during the Series A financing, where preferred shares are sold to investors. At this stage convertible notes and SAFEs usually convert. However, as advocated for in this post, any round can be priced including angel and seed rounds.
What are the Benefits to a Priced Round? The company knows exactly what % of the company is being sold in the round and the founders know exactly how much they are diluted. In a convertible note or SAFE financing there is some uncertainty as to how much of the company is actually being sold as these instruments typically convert on a fully diluted basis including the increase in option pool size required by the Series A investors yet the increase in the option pool is unknown until the Series A round. Additionally, priced rounds eliminate the confusion surrounding how numerous convertible notes and SAFEs, with different caps and conversion terms, convert (these calculations are difficult to understand, even for sophisticated parties).
We encourage our clients to explore priced common share rounds when considering the structure for their next early-stage investment round. Admittedly, some investors prefer convertible notes and SAFEs and others will reject a priced round valuation but accept the same valuation (or higher) as the cap on a convertible note or SAFE. While priced rounds may not work in all situations there is no harm in floating this as a possible investment structure. Indeed, sophisticated VCs, such as Fred Wilson of Union Square Ventures, agree that pricing rounds may be in the best interest of startups and their founders and should be explored rather than avoided.