
Venture capital has a self-dealing problem - julespitt
http://fusion.net/story/102544/venture-capital-has-a-self-dealing-problem/
======
ChicagoDave
Any investment group, upon hearing a pitch, will do one of three things; a)
ignore it, b) figure out how to leverage the new information in existing
pitches/plans, c) fund it. To even get a pitch in front of an investment group
takes a lot of networking to begin with, so the reality is by the time you
pitch, you're probably already an "insider" of sorts.

As an as-yet-successful entrepreneur, you should know that at any time your
idea or portions of your idea may be stolen or "adopted" by anyone who hears
you talk about it. And forget NDA's. No one signs those anymore...certainly
not an investor.

This is why, if you have an idea, you need to bootstrap it, get customers, and
generate revenue. Then let the investors come to you.

I think the entire "pitch" process is rigged and pointless. If you're going to
build something, be passionate, find great partners and advisers, and
bootstrap.

Let the VC's play their game. You weren't invited anyway.

~~~
Spearchucker
" _This is why, if you have an idea, you need to bootstrap it, get customers,
and generate revenue_ "

Another thing in addition to this - you need to out-execute future
competitors. Imagine that the idea is public anyway, and build it better than
anyone else could.

------
jklein11
I think the author's Simon Cowell example actually disproves his point. If you
wanted someone to win American Idol who would choose to do it? Someone who who
you have to train to sing well and coach them on the judges preferences? Or
would you choose the person who has worked with the judges for years, knows
exactly what makes contestants win or lose, and helps to make the decision
themselves. I would choose Simon Cowell, not because it would warm my heart to
see him win, and make me believe in the Meritocracy of American Idol, but
because he would be the best bet. Venture Capital is about making money, not
about giving everyone a chance to make their start up happen.

~~~
Hoffmannnn
I don't want someone to win American Idol, I want American Idol to pick the
best singer, whether or not said singer is a judge.

As an investor in a venture capital firm, though, you would expect the firm to
award funding to the best, not to the insiders. As a politician interested in
fostering a successful startup environment in your district, you would expect
the firm to award funding to the best, not to the insiders. As a fledgling
startup yourself, you would expect the firm to award funding to the best, not
to the insiders. As Simon Cowell, you would want to pick yourself. Therein
lies the issue. Only Simon Cowell wants Simon Cowell to win over other, more
qualified startups.

~~~
chralieboy
But the thing is, being an insider is usually a good indication of future
success.

If you already have those connections, that means you have a huge leg up on
the competition. You can raise more money at better valuations (meaning you
can make longer term bets, build a better team), you have access to better
talent, and you have access via your network to other executives that can make
deals happen.

We are upset because it isn't fair, but that isn't really the point. They want
to make a ton of money. Yes, they also want to change the world, but tenacity
and people skills (required in the VC word) are huge indicators of executing
on whatever vision you have.

------
LargeCompanies
Start-up success can be much easier if...

A. You went to the same ivy league schools as VCs

B. You have a certain look

C. They give you the opportunity to work with them & you take advantage/work
the opportunity to get funded.

Case in point, while I was participating in an incubator, there was a 20 year
old mentor. He was mentoring a 40 something first time female founder. He had
millions in funding and he went to sell his company for millions.

How did that happen when he had no previous experience. Well for one he
graduated from the same top school as his VC (one of the biggest), who in
which gave him a job working at the firm, who then funded his company and
steered it to a huge sale using his huge/immense network.

Start-ups can be very unfair if you don't look the part, gone to the same ivy
league school, given an opportunity to work with X huge VC & make the most of
it and or struck gold/got lucky by publishing the next big thing you had no
idea would take off.

VC is definitely a boys club filled with all the popular people from your high
school who left you out & talked trash about everyone who didn't fit their
part.

~~~
chralieboy
No need for an Ivy, just go to Stanford.

There is an argument for prescreening, but having been part of the interview
process for a high profile YC company in its early days, I can say that the
weight placed on "likeness" is very high.

The correlation between likeness and competence, not so much.

~~~
NhanH
Not to contradict your post. But Stanford is equivalent in term of prestige to
any Ivy out there, including Harvard. It seems like you agree with GP so
that's probably just a wording matter.

~~~
ssalazar
In CS/eng, indeed, more so in fact. For humanities, not as much.

------
coderzach
Venture capital isn't a game you can "win." The goal is to get a return on
investment, not to fairly distribute money. Starting a company isn't a contest
like american idol.

~~~
matthewowen
I think the bigger objections than "fairness" are:

1\. These might not be good funding decisions. Maybe investing in Keith
Rabois's new startup is a bad decision, but it is only happening because he's
a partner at Khosla. If you're an LP in a VC fund, this is something you could
reasonably be concerned about.

2\. If you're an entrepreneur pitching to a investors, you expect that the
pitch is being taken in good faith. If the investor is just taking your pitch
so that they can access your proprietary information and use it to inform
their own startup (funded by the firm you're pitching), that's pretty wack.

I have literally no information about these examples, so it wouldn't be
meaningful for me to hold an opinion on whether or not impropriety is
occurring. I also think that Keith Rabois probably has enough of a track
record that he could easily raise funding for pretty much whatever he wants to
do. I also suspect that most entrepreneurs aren't particularly worried about
point 2.

Nonetheless, this is clearly right at the nexus of the objections that people
raise about SV: that it's an old boy's network masquerading as a
"meritocracy". It just smells fishy. Sometimes things smell fishy and are
OK... but there's always a cost to doing things that smell fishy: the
appearance of impropriety is often just as harmful as impropriety itself.

~~~
jacquesm
VCs are under no obligation to invest in outsiders at all.

Yes, it's an old boys network, old boys networks are not illegal nor are they
bad. In fact they give the younger boys a fantastic opportunity to side-step
the whole thing and start their own network, that's _exactly_ what YC has
done.

Whenever you see something like this there is an opportunity.

~~~
matthewowen
Yeah, sure. I don't think that contradicts my post: I'm just saying that
people might be concerned about those things, and an LP might question whether
a given VC firm is best managing the assets under its control. The author
didn't say that VC firms were obliged to invest in outsiders, just that these
rules might give LPs more confidence that firms were behaving properly and in
their investors best interests.

That's not a wishy-washy "fairness" thing: it's a concern about whether the
firm is fulfilling its obligations to its backers. You don't have to agree
with the concern... but it isn't an unreasonable thing to be worried about.

~~~
jacquesm
The author is _not_ an LP with a VC. He feels he's in competition with the VC
partners for their money, different situation entirely.

As an LP he might take issue with this, but for that you have to be an LP
first and LPs typically do _not_ take issue with this but actually feel that
their money is well spent (whether that's correct or not is another matter).

------
jacquesm
By this definition every bootstrapper is 'self dealing'. VCs get to decide
how, when and where they allocate their funds, if they decide to bankroll one
of their own partners in a new venture then that's totally ok as long as the
partners and LPs are in agreement (it's their money after all) and you can bet
that they'll have extra outsiders scrutinize the deal to avoid being accused
of nepotism in case the company eventually goes south.

VCs with partners capable of executing on their own ideas are pretty rare, but
when it does happen it is usually because someone had a side project (possibly
even before joining the VC) that got legs (either unexpectedly or belatedly)
and this person then uses his _excellent_ VC contacts to secure a deal. And of
course he/she does not go to a competing VC, that would be a harder pitch and
it would be strange not to offer your partners a shot at the deal first.

All in all I can't see much wrong with this and if you think that it is
'unfair' you have to remember that VCs are not under any obligation to invest
in outsiders at all (private funds exist).

~~~
thesteamboat
Bootstrapping is not a conflict of interest. When people are operating as both
VCs and executives there are conflict of interest considerations.

Situations involving conflicts of interests are not inherently unethical, but
greater care is needed.

~~~
jacquesm
How can it be a conflict of interest if it is in the end _their own money_?
They get to spend it any way they want it and of course they will spend it on
those that they know better more readily than elsewhere.

It's not as if VCs are distributing public funds and those VCs that have taken
public funds (or pension funds) would likely never engage in a deal like this.

If you think you're 'in competition' with the VCs partners for capital you
have it backwards, they have the capital and they can dispense it at their
discretion, or even not at all.

~~~
thesteamboat
It sounds like you're defending a particular scenario that I'm not
understanding.

Do you agree that there exist hypothetical situations in which a company and a
VC firm investing in said company might have differing interests? Doesn't it
follow that someone with responsibilities to both parties has a conflict of
interest situation?

~~~
tptacek
This conflict is nothing new and is inherent to the model of organized private
investors picking companies to invest in. The exact same problem emerges when
an investor decides to invest in a portfolio competitor, or invests in a
company that pivots to that role. It's why startups are antsy about who they
allow to hold board seats.

~~~
thesteamboat
> This conflict is nothing new and is inherent to the model of organized
> private investors picking companies to invest in.

We're in agreement here.

Because this comes up in practice there are a slew of reasonable ways to deal
with these sorts of scenarios. I think the original article's "what do we do
about it" section falls nicely into this discussion.

I think the extent of my position here is that VC firms are at a heightened
risk of dealing with this type of conflict of interest problem, and would be
well served by having clear policies on how they resolve them.

edit:grammar

------
sharkweek
Two differing thoughts:

I'm not sure I would think the LPs would be all that concerned with this.
After all, a VC firm is going to live and die by its performance reputation,
so if their funds fail to return gains, it will haunt their firm for a long
time.

What I do buy though is Kevin's other point in the conflict of interest of
potential entrepreneurs walking into VC offices and pitching a great product
(editing out the word "idea" for clarity) that gets rejected. At that point
you've given up a lot of information with little recourse, and having a
partner at a firm run with the idea themselves, with strong funding and a
powerful network, would pretty much be a death sentence.

I have never seen this happen myself (although I do confess Seattle can be
pretty far removed from the daily dealings in VC world), and I do choose to
believe that most VCs operate with a moral compass, but it's still a
terrifying thought.

~~~
Kalium
It shouldn't be frightening. It should tell us all what we already know -
ideas are worth exactly nothing and execution is worth everything.

~~~
sharkweek
Generally I agree, but an entrepreneur who walks into a VC pitch with
execution at least partially accomplished should feel confident they're not
going to get their idea stolen.

~~~
Kalium
If you don't have enough execution under your belt that you have to worry
about your idea being stolen, you aren't in a good position to be pitching
VCs. That worry is a sign you should bootstrap more.

Your value proposition as a founder should never be as minimal as "It's my
idea".

------
sgwealti
I can't believe the folks who disagreed with you are hand-waving away a huge
conflict of interest.

~~~
InvisibleCities
"It is difficult to get a man to understand something, when his salary depends
upon his not understanding it!"

~Upton Sinclair

------
tolmasky
As long as the money is private, they should be able to do whatever they want.
If they're actually bad decisions (a worse startup getting money solely due to
being inside), then they'll suffer for it. If the decision however gives a
return, then what's the problem?

I don't feel suspicious of family's investing in their kid's venture -- wow
how unfair! so biased, they should have given the kid next door a fair
listening to as well!

The problem only arrises if bad decisions are then publicly de-risked (as is
the case in banks, etc -- don't know specifically if this happens in an
indirect way with VC's). But in and of itself -- "people you know" is one of
many possibly good or bad metrics you can use to invest your own money (or the
money interested to you by funders that know how you operate).

~~~
RodericDay
> I don't feel suspicious of family's investing in their kid's venture -- wow
> how unfair! so biased, they should have given the kid next door a fair
> listening to as well!

someone a while back made the case that SV is an offset economy where instead
of CEOs you have VCs, and instead of Managers you have Startup CEOs.

Keeping the vague analogy in mind, how is flooding your kids with easy credit
not available to other people not a form of nepotism?

~~~
mc32
It is, but what's the problem? It's like you taking your money, assuming you
earned it, and buying things for _your_ friends or _your_ family. So long as
your husband/wife/partner is okay, why should that be a problem?

Should I think it's unfair you spend nothing on me?

------
Sealy
I totally agree, poor moral standard is at the root of a lot of shady
investors.

I run a VC backed bitcoin startup myself and more then one of the investors we
pitched to as early back as two years ago have gone on to create their own
bitcoin-related companies in suspiciously similar product verticals to ours.

~~~
jacquesm
Do better vetting. You pitched to your would-be competitors, not to your
potential investors. In the 'angel' (what an interesting choice of word that
was) investor world this sort of thing is done far more frequently than in the
VC investor scene. Entirely different groups, though the former tend to try to
make money when the latter enters the scene (and it's not rare to see angel
investors be re-educated about the nature of investing during later rounds).

------
shawnhermans
I'm really struggling to understand the issue. I understand the issue of
conflict of interest when it comes to things like government contracts and
public corporations. Here conflict of interest occurs because the person makes
decisions on how to spend money that isn't their money. It is either the
taxpayer's money or the stockholder's money.

In a private company, like Andreessen Horowitz, they are effectively spending
their own money. If they choose to invest in a company founded by one of their
partners, I do not see the conflict of interest. From the outside we may
question whether or not the startup is really worthy of being funded, but it
really isn't our call to make.

But what if it was our call to make? Did they make a bad decision by funding
one of their own? Looking at his track record he already has experience as a
co-founder and a CTO. On top of having prior experience, he has worked as a
partner at Andreessen Horowitz for over a year. The people making the decision
whether or not to fund his startup have experience working with him. They
probably have a good idea of whether this person can or cannot deliver.

I think most people object to this, because they imagine a situation where a
better startup is not funded because the partners decided to fund their buddy
instead. Let us say that is true. For the sake of argument, assume this guy is
incompetent and should not be given funding. Imagine this guy worked at
Andreessen Horowitz for over a year and everyone knew he was incompetent, but
decided to fund him anyways just because they were BFFs.

I guess it is possible something like this happened, but I doubt it. I
recently finished reading Horowitz’s book The Hard Thing about Hard Things and
he doesn’t seem like the type of person who keeps incompetent people around
just because likes them.

The only valid objection I see is if they are using information provided to
them under a non-disclosure agreement to gain unfair advantage. But is this a
valid concern? As others have pointed out, most ideas are cheap. Even if that
information provides some short-term advantage, it won’t help in the long-term
as the market changes.

------
dsjoerg
Imagine if you gave money to Warren Buffett to invest and he turned around and
invested it in a company started by one of his own cronies?!

~~~
shawnhermans
Warren Buffett has a solid reputation of making excellent investments. As long
as the money returned a good investment, I wouldn't care at all.

------
andrewfong
Interestingly, venture capital LAW definitely has a self-dealing problem. Many
(if not most) major law firms in the valley have both company-side and
investor-side clients. And even if they don't, law firms often see a fair
amount of company-side clients based on investor referrals. As a result,
company-side counsel can often be reluctant to push too hard against investors
lest they risk jeopardizing future business.

My first company actually had a situation where the same firm represented both
us and the investor during our seed round AT THE SAME TIME. To be fair, this
was the investor's idea, not the law firm (and the law firm made sign all
sorts of waivers), and we ultimately saved a small amount in transaction fees
and I can't say we would've gotten much better terms with independent counsel.
But the entire affair makes me cringe a little every time I look back on it.

In case you're wondering, yes, there are rules against all of this. But you
can waive a lot of the rules by providing written consent (and many clients
don't think twice about this).

------
kyllo
The public company version of this is like a buyer at one company starting a
service provider as a side company and then using his authority as a buyer to
award himself a contract.

It's a conflict of interest and any publicly traded companies will fire you
for it because it's stealing from the (other) shareholders.

------
graycat
Oh, maybe the sky is not falling. Maybe it is not true that "We've got
trouble, right here in River City. Trouble starts with a _T_ and that rhymes
with a _V_ and a _C_ and they stand for _venture capital_ "!

Why? Well in _information technology_ (IT) venture capital, in recent years a
strong _theme_ has developed: The VCs want the founders to be _technical_ ,
e.g., design and write software. As I recall, the firm A16Z is an especially
strong supporter of this theme.

Well, then: For my startup, I've read a _lot_ of VC bios: My conclusion is
that only a tiny fraction of VCs are in any very significant sense _technical_
in anything in or very close to IT. E.g., when was the last time they designed
and wrote 10,000 lines of code? Invented a new algorithm? Did some technical
work prior to the software, e.g., the applied math of _machine learning_ or
_data science_ , e.g., some applied math for ad targeting? How about some
applied math for computer and network security via anomaly detection? How many
VCs are qualified to direct a major IT development project with planning,
hiring, training, software project management, server farm planning and
implementation including performance, reliability, security, growth potential?
Gee, let's keep it simple: How many VCs could step into to a slot as database
administrator of, say, a major site of SQL Server, Oracle, DB/2?

So, in an IT startup at the seed or Series A _level_ , why would a founder
want to hire a VC, and why would a VC want to invest in a VC as a founder or a
founder who would hire a VC? How 'bout they wouldn't?

Sure, at the Series B, C, ..., maybe some VCs could do _business development_
, marketing, setting up the sales _channels_ , running the sales organization.

Net, _bottom line-wise_ , the goal of the VCs and their limited partners (LPs)
is to make money, and a VC firm that doesn't make money will have a tough time
raising more. And, LPs may look with _surprise_ and even _concern_ at losing
bets on VCs within the firm. Or, such a VC darned better make money!

------
dlu
Hrm, didn't think this particular "Twitter fight" would end up as an article.
I see Kevin's point, but maybe I've been in the water too long. It doesn't
bother me much. There's plenty of networking and such already. Serial
entrepreneurs have nearly as many connections as any VC would anyways. And the
VC partner that is "self-dealing" isn't going to be able to deal himself
single-handedly. There are other partners at the firm.

There's lots of other unfair things in the Valley when it comes to privilege
like this.

------
JabavuAdams
It's interesting how once practices become the norm in a group or industry,
the practitioners become blind to conflicts of interest that are obvious to
outsiders. "This is the way it works." is useful information, but not a
convincing justification.

------
bsdpython
If the entrepreneurs, venture partners and investors are fine with it then who
are we to argue?

~~~
youssifa
The entrepreneurs who are fine with it are likely, for the most part, the ones
who actually get funded.

~~~
bsdpython
Well sure but nobody is owed a chance to get venture funding from a particular
fund. We are really stretching to find victims here, no?

~~~
jamiesonbecker
No.

------
jamiesonbecker
This actually happened to someone recently... VC invested millions in itself
and created a clone (and not a very good one). Needless to say, that company
is self-funding now but got stuck on that for months. (upside: now growing at
> 6% per week.)

------
aaronbrethorst
It's not corruption, just 'more of the same' nepotism. If you're shocked by
this, you haven't really been paying attention.

