Why AI Startups Have Two Different Prices for the Same Stock
The world of artificial intelligence is moving faster than any other industry in history. Every day, we hear about a new AI startup raising millions of dollars at a billion-dollar valuation. However, there is a strange secret happening behind the scenes. If you look closely at the paperwork, you will notice something confusing. These startups are often selling what looks like the same equity at two completely different prices. One price is very high, and the other is much lower.
To the average person, this sounds like a mistake or even something illegal. Why would a company sell a piece of itself to a venture capitalist for ten dollars while telling its employees that the same piece is only worth two dollars? This gap in pricing is not a mistake. In fact, it is a standard part of how startups work, especially in the high-stakes world of AI. In this article, we will explore exactly why this happens, how it affects everyone involved, and why AI companies are seeing such huge gaps in their stock prices today.
Understanding the Basics of Startup Equity
Before we dive into the “why,” we must understand the “what.” In a traditional public company like Apple or Google, there is usually just one price for a share of stock. If you go to a trading app, you see the price, and that is what everyone pays. Startups are different. They use different classes of stock to give different people different rights. Specifically, they use preferred stock and common stock.
What is Preferred Stock?
Preferred stock is what professional investors, such as venture capitalists, buy when they put money into an AI startup. These investors are taking a huge risk by giving a young company millions of dollars. Because of that risk, they want extra protection. Therefore, preferred stock comes with “special powers.” For example, if the company is sold, the people with preferred stock get paid back first. Additionally, they often have the right to block certain decisions or get extra shares if the company’s value drops later. Because these shares have more “features,” they are naturally more expensive.
What is Common Stock?
Common stock is what the founders and the employees own. It is the basic version of the company’s equity. It does not come with the same “get paid first” guarantees that preferred stock has. If the company fails or is sold for a low price, the common stockholders might get nothing at all. Because common stock has fewer protections and fewer rights, its value is lower than the preferred stock. Consequently, there is always a gap between the price an investor pays and the price an employee sees.
The Role of the 409A Valuation
You might wonder who decides exactly how much cheaper the common stock should be. This is where the 409A valuation comes in. In the United States, the government requires private companies to hire an independent firm to value their common stock. This is a tax rule. The goal is to make sure that when employees get stock options, they are paying a fair market price for them.
Furthermore, these independent firms use a specific logic. They look at the preferred price and then subtract the value of all those “special powers” we mentioned earlier. Since employees do not get to be paid first and do not have voting control, the firm decides the common stock is worth significantly less. Often, the common stock price is only 20% to 30% of the preferred price. This is a huge benefit for employees because it allows them to buy into the company at a much cheaper rate, which leads to bigger profits if the company goes public later.
Why AI Startups are Seeing Massive Price Gaps
While this price gap exists in all startups, it is becoming much more visible and extreme in the AI sector. There are several reasons why AI companies are selling equity at such different prices right now. Most of these reasons come down to the massive amounts of money required to build AI technology.
Huge Capital Requirements
Building a powerful AI model is not like building a simple mobile app. It requires thousands of expensive computer chips and massive amounts of electricity. Therefore, AI startups need to raise billions of dollars very early in their lives. To get this money, they have to promise investors a lot of protection. When investors demand more rights, the price of the preferred stock goes up, while the common stock stays lower because those protections do not apply to it.
The “FOMO” Factor in AI Investing
Fear of missing out, or FOMO, is driving AI valuations to the moon. Many venture capitalists are desperate to get into the “next OpenAI.” As a result, they are willing to pay a very high price per share just to be part of the deal. However, the actual “fair market value” of the company might not have caught up to that hype yet. The 409A valuation firm stays more grounded in reality, looking at actual revenue and assets. This creates a situation where the investor price is based on future dreams, while the employee price is based on today’s reality.
How the Two-Price System Benefits the Company
You might think that having two prices would be a headache for a founder, but it is actually a very useful tool. First, it helps with hiring. If an AI startup told a new engineer that they had to pay $50 per share because that is what a VC paid, the engineer would never join. By keeping the common stock price low, the company can offer “cheap” equity as a reward for the employee’s hard work. This makes the total compensation package much more attractive.
Secondly, it keeps the tax office happy. If a company gave an employee stock at a huge discount without a 409A valuation, the government would see that discount as income and tax the employee immediately. By having an official “low price” for common stock, the company protects its workers from massive tax bills they cannot afford to pay.
The Rise of Secondary Markets
Another reason we see this price gap so clearly today is the rise of secondary markets. In the past, you couldn’t sell your startup stock until the company went public. Today, there are platforms where employees and early investors can sell their shares to other private buyers. In these markets, people are often buying common stock, but they are paying prices that are closer to the preferred price.
However, this creates a confusing situation for the company. If an employee sells their common stock for $80 on a secondary market, can the company still claim the common stock is only worth $20 for its next 409A valuation? Often, the answer is no. This creates “upward pressure” on the common stock price. Many AI startups are trying to limit these secondary sales because they want to keep the employee price low for as long as possible to help with hiring.
Risks of a Large Price Gap
While having two prices is normal, a gap that is too large can be a warning sign. If a startup sells preferred stock at a massive valuation but the common stock is valued very low, it might mean the investors have “aggressive” terms. For instance, they might have a “2x liquidation preference.” This means they get double their money back before employees get a single cent.
In this scenario, if the AI startup is sold for a good price, but not a “great” price, the investors might take all the money, leaving the employees with nothing. This is why it is so important for AI workers to look beyond the headline valuation. The price an investor pays is only half the story; the rights they get for that price are what really matter.
Conclusion: A Tale of Two Values
In conclusion, AI startups sell equity at two different prices because they are essentially selling two different products. The preferred stock sold to investors is a high-protection financial instrument designed to reduce risk. The common stock given to employees is a high-reward tool designed to attract talent. As long as AI continues to require massive amounts of capital and generates intense investor interest, these price gaps will likely remain wide.
For founders, balancing these two prices is a delicate dance. They must keep investors happy with high valuations while keeping employees motivated with affordable stock. For anyone looking to join the AI revolution, understanding this gap is essential. It is the difference between owning a piece of a “unicorn” and actually making money when that company finally crosses the finish line. Equity is complex, but in the fast-paced world of AI, knowledge is the best investment you can make.
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