In startup fundraising, success stories dominate headlines. We hear about multi-million-dollar exits, billion-dollar valuations, and the seemingly endless amounts of capital flowing into startups. Behind the scenes, many founders and employees find themselves in a precarious position—despite all the hype, they walk away with little or nothing when their startup is acquired or goes public.

A recent example is Divvy, a rent-to-own startup that was acquired for $1 billion. Despite the impressive sale price, it was reported that common shareholders, including founders and employees, would receive nothing from the sale.

Another recent example is Freetrade, a commission-free investment platform founded in 2016. After rapid growth and multiple crowdfunding rounds, Freetrade was acquired by IG Group for £160 million in January 2025. While early investors saw significant returns, some later-stage crowdfunders faced losses exceeding 80% of their investments.

The culprit? Liquidation preferences and overinflated valuations that create an illusion of wealth but leave the people who built the company with empty pockets.

The High-Valuation Trap: More Money, More Problems

It’s natural to want to raise capital at the highest possible valuation. After all, a higher valuation means less dilution for founders and employees, right? Well, not exactly.

Venture capitalists are not in the business of giving away free money. When they agree to high valuations, they often structure their investments with strict liquidation preferences—essentially clauses that ensure they get paid before anyone else in the event of an exit.

For example, a 2x liquidation preference means that if an investor puts in $50 million, they get at least $100 million back before common shareholders (including founders and employees) see a single cent. If the company sells for $120 million, it might look like a win, but in reality, those who hold common shares—often the people who built the business—walk away with scraps.

Founders Are Forced Into Risky Bets

Once a startup raises money at a high valuation, the pressure is on to justify it. Investors expect rapid growth, and often, the only way to sustain these expectations is by taking increasingly aggressive bets. This can mean expanding too quickly, pursuing unprofitable customers, or launching products prematurely—all in an effort to keep up appearances for the next funding round.

But these tactics are often unsustainable. If the company doesn’t hit its aggressive targets, it may struggle to raise more funds or be forced into an unfavorable exit. Investors, protected by their liquidation preferences, can still walk away with a profit. Founders and employees? Not so much.

Employees Are the Last to Know

Most employees joining a startup believe in the promise of equity. They accept lower salaries in exchange for stock options, convinced that one day their hard work will pay off in the form of a massive payday. But few truly understand how liquidation preferences work—and why they might end up with nothing.

Even if a company exits for what seems like a life-changing sum, complex financing structures can mean employees’ stock options are effectively worthless. Worse still, they may have spent years at the company, pouring their energy into something that never materialized into financial security. This leads to frustration, disillusionment, and ultimately a loss of trust in the startup ecosystem.

Even Customers Suffer

It’s not just founders and employees who suffer from the high-valuation cycle—customers do, too. When a startup is pushed to scale rapidly, product quality often takes a backseat. Customer service suffers, and long-term sustainability is ignored in favor of short-term growth.

Many promising startups collapse under their own weight, leaving customers scrambling for alternatives. Instead of building enduring businesses, many founders are forced to play a high-stakes game that benefits investors but leaves customers in a lurch when things go south.

Why Founders Struggle to Break Free

Founders aren’t just competing for customers—they’re also fighting for top-tier talent and the best investors. In a market where everyone else is touting sky-high valuations and PRing impressive growth numbers (often inflated by investor-friendly liquidation preferences), founders feel pressured to play the same game. If they don’t, they risk being overlooked by top candidates who are lured in by the promise of lucrative equity packages elsewhere, or by investors who expect aggressive growth stories to justify their bets.

This puts founders in a nearly impossible position: either sustain the narrative of being the “next big thing” and raise on terms that could later backfire, or take a more cautious approach and risk missing out on the best talent and capital. The problem is, once they’ve committed to the high-valuation cycle, there’s rarely an easy way out without jeopardizing their business, their employees, and their own financial future.

How Founders Can Avoid This Trap

While it may seem like a losing battle, founders can take steps to protect themselves, their employees, and their businesses from falling into this all-or-nothing cycle.

  • Negotiate Balanced Terms: Founders should push for fairer investment terms, including lower liquidation preferences and more equitable cap table structures. This is easier said than done, but if more founders hold their ground, the standard could shift.
  • Educate Employees: Employees need to understand the fine print of their stock options and how liquidation preferences affect their potential earnings. Transparency fosters trust and helps them make informed career decisions.
  • Embrace Sustainable Valuations: Rather than chasing sky-high valuations, startups should focus on sustainable growth that aligns with the real value they’re creating. This leads to healthier companies and better long-term outcomes for everyone involved.

Earlier IPOs Offer a Path to Stability

The current private market dynamics have skewed incentives, leading to high valuations that often benefit later-stage investors at the expense of founders and employees. One potential solution? A return to early-stage IPOs.

Early-stage IPOs could help flatten the cap table and provide more liquidity for all shareholders—not just venture capitalists. By going public earlier, startups would be subject to market-driven discipline, making it harder to inflate valuations artificially.

Public markets also offer greater transparency, allowing investors and employees alike to have a clearer picture of a company’s real financial standing. Additionally, an IPO at an earlier stage could give companies the capital they need while reducing reliance on later-stage investors who often demand aggressive liquidation preferences.

While this shift may not be easy, it could ultimately create a healthier startup ecosystem—one where success is defined not just by funding rounds but by sustainable business growth.

Build for the Long Term, Not the Next Round

Startups should exist to build great products, create value, and improve lives—not just to satisfy investor returns. But in today’s venture climate, the latter too often takes priority. If the startup ecosystem is to remain sustainable, we need to rethink the incentives that drive it.

The key is to prioritize long-term health over short-term hype. Founders who navigate these pitfalls thoughtfully will not only create more resilient companies but will also ensure that the people who actually build them—employees, customers, and yes, even founders themselves—share in the success they create.