A recent development among high-growth VC-backed companies is the equity financing conducted at multiple valuations at once. A company raises, for example, a Series C-1 round at a US$2 billion post-money valuation and a Series C-2 round at a US$2.5 billion post-money valuation, with both closings occurring at or around the same time. The structure can be a sensible response to real circumstances, but it introduces complexities that a single-price round does not, and several of them are easy to get wrong if they are not addressed at the outset.
Clear Rationale Is Key
The immediate step-up from one tranche to the other has to be explained, and the explanation has to hold up with existing investors, both groups of new investors, employees, and eventually the public. Two justifications are most common.
The first is a milestone: a major customer contract, a product launch, or another market transaction (such as a secondary sale or a competitor’s financing) that occurs after the first tranche is agreed to via a term sheet and credibly changes the company’s value.
The second is scarcity: a company in high demand may admit additional investors beyond the original allocation only at a higher price (i.e., if you want in, you’ll need to pay a step up in valuation).
Either rationale can work, but should be articulated clearly and consistently from the start. The board will want to document why it approved sales at different prices within days of each other; without a clear story, the lower-priced tranche can look like a sweetheart deal and the higher-priced tranche can look like an overpayment. Messaging settled before the term sheets are signed tends to survive; messaging developed after the fact rarely does.
Documentation
Two-valuation rounds are typically documented in a single stock purchase agreement under which the company sells two series of preferred stock (for example, Series C-1 and Series C-2) that are identical in all respects other than original issue price, conversion price, and per-share liquidation preference. The two series typically rank pari passu in liquidation, although investors in the higher-priced series may seek seniority. The representations and warranties, covenants, closing conditions, and disclosure schedules are the same for both series. The charter amendment creates both series at once, and the investor rights, voting, and right of first refusal and co-sale agreements are amended once to cover both. Where the closings are not simultaneous, the agreement should address whether they are cross-conditioned, how representations are brought down to the later closing, and what happens to the option pool and other pre-money adjustments if one tranche closes and the other does not.
Anti-Dilution and Voting Thresholds
Anti-Dilution
Standard broad-based weighted average anti-dilution protections are triggered when the company issues shares at a price below a series’ conversion price. In this situation, the anti-dilution protections in the charter would typically expressly exclude all shares issued in the financing. In addition, careful attention should be paid to the pre-emptive rights and other related language in typical NVCA-style documents to ensure no rights are inadvertently triggered by the two-valuation structure.
Voting Thresholds
Two-valuation rounds also impact the company’s voting mechanics. The first question is whether the two series vote together as a single group on an as-converted basis or separately. Treating them as a single group for protective provisions, board designation rights, and “requisite holder” definitions is the usual approach; a separate series vote could hand a small tranche a veto that no one intended (though the series with the higher price per share may push for a separate set of consent rights related to economic terms). Thresholds expressed as share counts, such as “major investor” definitions, information rights cutoffs, and the like, should be revisited, since a given dollar investment buys more Series C-1 shares than Series C-2 shares. Lastly, the approvals for the financing itself should be computed carefully: where both series are authorized in the same charter amendment and the financing is approved at the outset, the requisite consents are typically measured against the pre-closing cap table; if, instead, the second tranche requires a separate approval (for example, a later charter amendment), that approval must account for the shares issued in the first closing.
The Pro Forma Cap Table Is Key
In a multiple-valuation round, a well-prepared pro forma is indispensable because each party’s ownership depends not only on how much it invests but on which tranche it invests in and whether the other tranche closes. A pro forma should show at least the following:
- Dilution from each tranche: The fully diluted ownership of every holder under each scenario, taking into account all expected investments, should be calculated upfront. New investors and existing stockholders need to understand how their percentage changes if the other tranche does (or does not) close as planned.
- The option pool true-up: Financing rounds frequently include an increase to the option pool as part of the pre-money valuation, such that it does not dilute new investors. With two tranches, the parties must decide whether the pool is sized once (and on which valuation) or trued up in each tranche, and in each case, who bears the resulting dilution.
- Necessary votes: Which holders, after each closing, will hold the thresholds needed for future protective provision votes, board designations, and amendments, so that no one is surprised by a shift in control dynamics once the second tranche is in.
- Authorized shares: Whether the charter authorizes enough preferred stock for both series, including subsequent closings, and enough common stock for conversion of both series plus the expanded option pool.
Equity Compensation
A multi-valuation financing complicates equity incentive awards and their corresponding valuations. Companies should model the expected outcome in advance, consider whether grants to pending hires should be approved in advance, and be prepared to explain the jump in valuation to employees. The two prices also raise financial reporting questions – which price is the fair value reference for stock-based compensation, and how is the difference accounted for – that are worth raising with the company’s valuators and auditors early.
Press Releases and Public Disclosure
If a press release is issued in connection with the financing, additional consideration must be given to accuracy and timing. “Raised $300 million at a $2.5 billion valuation” is at best imprecise, and at worst, misleading, if most of the money came in at $2 billion. A premature announcement poses a separate problem in that it may impact the company’s ability to fundraise privately if the company posts a press release about one tranche while the other is still not closed; such public communications may be viewed as general solicitation or as a way to inaccurately bolster interest in the higher valuation. Press releases should also be accurate on the facts: if a milestone has not been achieved or financing is not yet closed, disclosure should be clear. The better practice is to announce only after the final closing, to describe the structure accurately (or at a level of generality that is not misleading), to coordinate with the investors’ own announcements, and to hold employee communications to the same standard.
Secondaries in the Round
Late-stage financings now routinely include a secondary component, and a multi-valuation round adds the question of which valuation the secondary should be priced against. Secondary purchases are often made at a discount to the primary price; with several primary prices, the choice of the “anchor” valuation is both a negotiating point and a signal to the stockholder base.
A financing at two or more valuations is manageable (and indeed has become more mainstream), but pitfalls are plenty and it must be done only with careful planning and legal guidance.
