This Controversial Fundraising Hack Is Booming—but It Might Not Be Smart for Your Startup

A new report found that some AI startups are using a multitiered fundraising maneuver to inflate their valuations. Here’s how it works.

BY BEN SHERRY, STAFF REPORTER @BENLUCASSHERRY

Founders desperate to separate their AI-powered startups from the pack are turning to increasingly creative solutions, and according to a new report from The Wall Street Journal, it’s changing how startups and investors are structuring fundraising deals. 

The Journal reported that AI companies are increasingly using a back-to-back or multi-tiered fundraising tactic, in which a company sells shares to a prestigious lead investor at one valuation, and then turns around and sells shares to other investors at a much higher price. 

This tactic has a few benefits: The startup gets to boast about its historic growth, which can help them win future business, and the lead investor’s stake in the company becomes more valuable overnight. Carta, a financial software provider, told the Journal that deals of this nature have been rising in popularity, with the company recording 20 such deals over the last six to 12 months.

This kind of fundraising can be beneficial and detrimental to startup employees in equal measure. A higher valuation means that employees can sell their shares for more money, but it also means that the price employees pay to buy new shares increases as well. 

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One company that has engaged in multi-tiered fundraising is Serval, a startup that describes itself as selling “AI agents for IT.” In October, Serval raised a $47 million series A, and according to the Journal was valued at $220 million and had $1 million in annual recurring revenue. In early December, according to the Journal, Serval closed a private deal with venture capital firm Sequoia that valued the company under $400 million, then days later, on December 11, announced that it had raised a $75 million series B at a valuation of $1 billion, led by Sequoia. 

In a blog post explaining its rationale for the investment, Sequoia confirmed that it had “preempted” Serval’s series B fundraise, meaning the investor was able to grab a stake in the company before it was offered to others. Peter Wendell, founder and former leader of venture capital firm Sierra Ventures, told the Journal that this type of investment is a method to “make it look like you have a high valuation,” while cutting a deal for the lead investor. 

While this type of fundraising is legal, according to lawyers who spoke to the Journal, not all investors are all so enthused. Former Cisco CEO and current venture capitalist John Chambers told the publication that “most of the VCs I interface with, they would not do a deal nor would they participate in a deal where some investors would get dramatically better terms at the same time.”

Whether or not this is a wise way to raise funds and gain notoriety is still up for debate. It’s undeniable that a unicorn valuation will make potential customers and clients take note, but if your valuation isn’t reflected in the day-to-day revenue of your company, that big number could feel more like an albatross than a selling point. 

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