When founders start the process of raising a priced round, there are fundamental business decisions that need to be made before negotiations start in earnest. The first decision will lead the headlines: the valuation of the company used in the priced round.

The valuation of a company can materially impact the startup's business strategy for the next 12–24 months. It also determines founder dilution. Therefore, it is important for founders to understand the implications of raising at different valuation amounts before looking at a term sheet.

The company valuation is only a piece of the larger priced-round puzzle. I’ve found that the best founders learn to think like the investors they are negotiating with, and this requires an understanding of shareholder rights that the founder may not be familiar with prior to raising their first priced round.

What is a Priced Round?

A priced round is the industry term for an equity financing in which a startup issues preferred stock at an agreed‑upon valuation, such as in a Series Seed, A, or B round. It follows a negotiation process where founders and investors agree on the company valuation (calculated as a pre-money and post-money valuation) and resulting price per share. Investors buy preferred stock at this price per share. These preferred shares are almost always convertible into common stock at the investor’s election, most often at an exit event, such as a sale of the company or an IPO. Investors typically have the potential to generate larger returns the earlier they invest.

Terms to Know

Founders should understand the following, which dictate most priced‑round negotiations:

Company Valuation: In the priced round context, this is a negotiated value that determines the price per share that investors receive, and therefore the percentage equity interest that they have in the company at the round’s closing.

Down Round: A subsequent financing at a lower company valuation than the previous priced round. This can result from underperformance relative to expectations or from broader shifts in market conditions.

Anti‑Dilution Rights: Allow investors to shift dilution onto common stockholders in the event of a down round. In practice, this works by providing preferred stockholders downside protection from the economic risk of a priced round.

Liquidation Preference: Determines how much investors in the priced round are paid before common stockholders (including founders and employees) in the event of a sale, liquidation, or exit. The more advantageous the liquidation preference, the better the downside protection is for investors in that series.

Veto or Blocking Rights: Contractual rights given to investors that allow them to block major company actions, even as minority stockholders. The more veto rights founders grant, the less control they retain over the company’s major actions - even if they still maintain board control. Examples of actions that can be vetoed include the approval of future priced rounds and exit transactions.

Control Provisions: Rights that allow investors to have approval power over a wide variety of future company actions, depending on what is negotiated. Investors can have control provisions over changes in board composition, debt financings, and even executive compensation. When granting these rights, founders must learn to share a seat at the table while making these decisions, which can be a unique (and difficult) adjustment.

What Can Founders Handle on Their Own?

In a typical priced round, founders routinely develop a fundraising plan to set expectations for the round. This requires understanding the pros and cons of raising at different company valuations.

Raising at a High Valuation

Most founders believe that a higher valuation is always a better valuation. Raising at a high valuation is not the best move for every startup at every stage.

Pros of a High Valuation

• Signals positive momentum for the startup and investor confidence. 
• Pleases early investors who already see a paper return on their investment.

Cons of a High Valuation

• Investors will expect growth at accelerated speed in order to generate an attractive return on their investment.
• The next priced round becomes more difficult, and some companies feel forced to burn through existing capital in order to aggressively grow and avoid a future down round. Startups in this position may have to make uncomfortable decisions, such as cutting hiring, scaling back operations, or forgoing strategic opportunities.
• There is a higher bar to clear when exiting the company in order to generate the desired return for shareholders.

Raising at a Low Valuation

This is not always a bad outcome for startups with a clear trajectory. Some startups can raise conservatively while continuing to grow.

Pros 

• Raising a smaller amount at a conservative valuation allows the startup to continue its growth trajectory at a more comfortable pace without unduly diluting the current holders.
• The startup avoids unnecessary pressure to grow into an aggressive valuation in the near term and shields itself from down round risks.

Cons

• Low valuations (if lower than prior valuations at rounds) can trigger liquidation preferences and anti-dilution rights, which is often a cascade failure issue for founders. 
• There are increased dilution risks when raising at a low valuation, and founders need to make sure they do not give up too much of the company too soon.

Beyond a fundraising plan, founders should also familiarize themselves with the key terms (as defined above), along with getting to know potential investors. Granting investors certain protective provisions can absolutely be worth it if their expertise, capital, and network opens new doors for the startup.

When Is It Risky to Proceed Without Counsel?

Founders should reach out to their startup attorney when investors negotiate protective provisions that could have long‑lasting impacts on the company. Some specific points include:

• Before signing a term sheet of any kind, even if an investor assures you that it’s all standard and market. A startup attorney puts the company first, indicating with practical guidance whether terms are actually market, or even the best you can get. 
• Any terms with aggressive anti‑dilution or control provisions. Legal counsel can help founders understand how these terms will interact with future rounds and exit scenarios.
• When an investor is requesting veto rights over acquisitions or other major decisions. These provisions can significantly constrain the company's flexibility and should be carefully negotiated.
• If a down round appears likely. Counsel can help founders understand how liquidation preferences, anti‑dilution adjustments, and other provisions will affect both the cap table and negotiations with new and existing investors.

A Simple Founder Checklist for Priced Rounds

Use this checklist to decide what you can do yourself and when to loop in counsel:

1. Understand the pros and cons of raising at different valuations, and how much runway the company needs before it is ready to raise again, if necessary.
2. Scan term sheets for protective provisions such as anti‑dilution rights, liquidation preferences, veto rights, or control provisions. All of these are worth flagging for legal counsel before signing.
3. Understand the impact of the rights you are granting to investors, and consider how these rights may limit your future ability to run the company.
4. Consider the public‑relations element of the raise for your company. Weigh the legitimacy that it may provide to the company against the cost to ownership and control.

Charlie Sommers is a startup and venture capital attorney based in Chicago, IL. He represents founders, startups, and venture capital funds in a wide variety of corporate transactions, including raising capital and navigating issues associated with rapidly-growing startups. He can be reached at csommers@founderslaw.com.