What is an unpriced round?

As angel investors, we often invest in startups during their earliest funding stages before they have significant traction or revenue. During these unpriced seed rounds, companies are not yet ready for a full priced equity round that establishes a formal valuation.

An unpriced round allows investors to provide funding to a startup, but instead of receiving shares immediately at a set valuation, the shares are issued later during the next priced round, typically at a discount to that round's valuation.

One of the most common ways unpriced rounds work in India is through CCD/CCPS (Compulsorily Convertible Debentures/Preference Shares). With CCD/CCPS, investors advance cash to the startup, but instead of immediately converting that cash into shares at a valuation, there is an agreement that the cash will convert to equity at the next priced round when a lead investor sets a new valuation.  

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The key terms in a CCD/CCPS specify:

1) The discount rate - This is the percentage discount the CCD/CCPS investors receive compared to the new priced round investors. Common discounts are 10-30%.

2) The valuation cap - This acts as a ceiling on the price the CCD/CCPS converts at, providing more favorable pricing to the holders if the new round valuation exceeds the cap.

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To illustrate how these terms work, let's look at an example:

Let's say you invest in an unpriced CCD/CCPS round with the following terms:
Discount rate: 20%
Valuation cap: $20M
Valuation floor: $10M

Now let's consider three possible cases for the startup's future fundraise valuation:

Case 1: Startup raises at $30M valuation
- Valuation based on 20% discount: $24M
- Valuation based on $20M cap: $20M
- Valuation based on $10M floor: $10M
You would receive shares at a $20M valuation thanks to the valuation cap.

Case 2: Startup raises at $20M valuation  
- Valuation based on 20% discount: $16M
- You would receive shares at a $16M valuation thanks to the discount rate.

Case 3: Startup raises at $7M valuation
- Valuation based on 20% discount: $5.6M
- Valuation based on $10M floor: $10M  
You would receive shares at a $10M valuation because of the valuation floor.

As this example shows, the key terms like discount, cap, and floor combine to provide different pricing benefits depending on the future valuation.

There are advantages and tradeoffs, but for very early stage companies, the unpriced CCD/CCPS round provides a valuable funding path balancing investor and founder interests.

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There are several key advantages to CCD/CCPS notes and unpriced rounds for both the investors and the startup:

For the Startup:
- Simplicity - CCD/CCPS are standardized contracts that avoid lengthy and costly negotiations over a priced round.
- Extend runway - Raising an unpriced round can provide 12-24 months of runway to continue developing the product and metrics before setting a formal valuation.
- Avoid excessive dilution - Early stage valuations can be highly speculative. Deferring the priced round allows proof of concepts and mitigation of dilution risk.

For the Investors:
- Valuation prioritization - CCD/CCPS investors get shares at a discounted price to the lead priced round investors while maintaining pro rata rights.
- No interest - Unlike convertible debt, there is no interest accruing.
- Simplicity - The standardized CCD/CCPS avoids protracted and costly negotiation.

Of course, there are also tradeoffs with unpriced rounds. Investors are taking on more risk by not baking in a valuation floor, and startups may face more dilution down the road if they cannot raise at a higher valuation.

For very early stage companies, however, the unpriced CCD/CCPS round provides a valuable funding path that balances investor and founder interests. At Misfits, we view them as an important part of the startup fundraising journey in India.

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