Those Guys Aren’t Real Venture Capitalists
By Anna Johnson on February 25th, 2010Looking for venture capital for your startup? Beware the ‘pseudo VC firms’ that promise you millions, but are really out to get YOUR money.
Sad to say, I’ve come across a few venture capital (VC) firms that aren’t really VC firms. These are businesses whose main objective is to prey on, and extract money from, both startup companies and/or other (legitimate) investors.
It may be that firms like these wouldn’t last two minutes in sophisticated venture capital hubs such as Silicon Valley, Boston, New York City, Los Angeles, Seattle and Boulder, but in places where there are plenty of startups looking for capital, but relatively few venture capital firms to provide it, the pseudo VC firms seem to thrive.
The thing to note is that pseudo VC firms aren’t straight-out con-artists. They are often real businesses that do real things. But while they may call themselves venture capital firms, they aren’t really in the business of raising and investing venture capital in order to make multiples on their original investment.
These pseudo VC firms are actually service providers whose business model rests on extracting fees from either or both the startups they ‘invest’ in and the other investors they enlist to ‘co-invest’ with.
Some of these firms describe themselves as investment banks. That’s actually more accurate than ‘VC firm’ – although rather self-aggrandizing – in the sense that, like investment banks, such firms make money on the deal i.e. finding investors to invest in a given startup. But when these pseudo VC firms pile on fees for various other ‘services’ it’s readily apparent that not only are they not VC firms, but they’re not really investment banks either. They’re really services providers.
Of course, there’s nothing wrong with a services provider! Lawyers, accountants, consultants, recruiters, real estate agents, etc all play their part in helping startups get off the ground. But there’s a massive difference between a firm that provides the money (in return for equity) and one that takes the money (in return for supplying services). And it’s just plain misleading for a pseudo venture capital firm to attract startups with the promise of funding, when its real agenda is to extract fees from those startups.
So what are the signs of a pseudo VC firm? Basically, anyone who charges you, the startup, any kind of fee is not a real venture capital firm. If they charge a fee to find investors – they’re not venture capitalists. If they charge a fee to review, write or submit your business plan – they’re not venture capitalists. If they charge you to pitch your idea to them – they’re not venture capitalists. If they arrange for funding for your business and then charge your company ‘consulting’ fees – they’re not venture capitalists.
Also, while it’s fine and normal for a VC firm to derive a management fee for managing its venture funds (the pools of investors’ funds used to invest in startups) it’s not normal for the ‘VC firm’ that has funded your company to turn around and charge other potential investors a ‘due diligence’ fee in order to evaluate your business!
A real VC firm does not use its portfolio of investee companies to ‘steal from Peter, in order to pay Paul’ by forcing each company to purchase the services of its other portfolio companies. Nor does it force two of its companies to merge in order to dilute the shareholdings of the company founders.
No, these activities are not about obtaining ‘leverage’ or ‘synergies’; they are the activities of a firm looking to extract money in ways other than a legitimate exit (IPO or sale to another company).
As you may have guessed, I have seen these kinds of shenanigans go on with pseudo VC firms. Again, nothing wrong with a firm being a service provider and explaining that they provide a range of services in return for specific fees. But NOT when it calls itself a VC firm.
