Ask HN: Do VCs often do this? | Hacker News Reader

Ask HN: Do VCs often do this?

9 pointsthrowaway-vc-q8 comments

I worked for a company a couple years ago which was in a very odd situation. Let’s call them Company A. They didn’t seem to realize that they were being vastly overcharged for IT services by a “firm” that was owned in part by the individuals running the VC firm that gave them funding. They primarily invested other people’s money, not their own. This ultimately drove the business into the ground, as they had software that barely did anything and no money left for anything else. They charged over half of the total “investment”, hundreds of thousands of dollars, for an app one guy could have built in 2 months. At the same time this was happening, sketchy IT firm was giving free help to their biggest investment (Company B) in an attempt to try and keep them afloat.

It seems to me that the investment in Company A was really just a means of moving money to Company B, which was in a different fund that was running dry. That, and pressuring companies to use the sketchy IT firm to begin with allowed the managing partners of the VC to shift money into their own “business”. All of this was even occurring on the same floor of the same office building.

Now I’m just a junior dev now, and this was just an internship I had, but to me this seems like it should be multiple very serious crimes. But I know nothing about that, and I haven’t dealt closely with any other VCs.

Is this kind of behavior relatively common? Is it even illegal?

Sorry if this is off topic or not a good post for HN but nobody else I’ve ever talked to about this has had much to say, and this seems like the most knowledgeable group of people I know of about this sort of thing.

I've worked in and around private equity as an investor in buyout and VC funds in the US.

There's a fundamental misalignment of interest here as investors might not be the same across both funds.

VCs are supposed to disclose intra portfolio company dealing and services to investors (LPs). They may even require LP approval to do so.

Some private equity firms have historically charged "consulting/management" fees to portfolio companies and they can be offset against management fees at fund by 50% to 100%. Private equity firms in the past have been fined multiple millions of dollars for not disclosing these arrangements to LPs.

This on the other hand looks like intra portfolio company services and if everything you say checks out, I can't imagine the investors approved this. If they know about it or approved it, they may have had the wool pulled over their eyes.

If it is as bad as you say it is, then it's probably illegal and could warrant the SEC getting involved.

To add to my comment., the key here is if one portfolio company is selling its services to another portfolio company for an inflated price (i.e. above what is considered to be market).

From my other comment below: "One fund could be doing very well and the VC might be in carry whilst another is doing poorly. So if you're the VC you'd want to move money into the more successful fund to generate better returns and higher carry (i.e. 20% of the profits after fees)."

There is a big difference between a VC firm offering services like recruiting, technical support, etc. to portfolio companies and Partner 1 is partners in a side business with his old college buddy and post-funding, Partner 1 says, "Use this firm to do XYZ". There are a couple of issues, but for most, especially first-time founders, VCs on your board, especially the lead, has a disproportionate amount of influence over a CEO. Secondly, Partner 1 should disclose this to his own VC fund / LPs; it's like any other conflict of interest disclosure you would make at any other job.

I haven't heard of this type of issue, more often it's use this law firm or recruiter or whatnot. Oftentimes they have relationships, get discounts, dinners / perks, etc. It's along the same lines as the $2,000 post-close dinner / night out many VCs come to expect.

Sounds bad.

Remember, a VC is just someone who has convinced someone else to invest their money for them. Most money is invested wisely with smart, upstanding VCs, but bottom-feeding VCs seem to be able to find money to invest too. Because there's so little regulation, the dodgiest VCs are worse than, say, the dodgiest real-estate agents.

The victims in this situation are the VC's LPs, whose money may be ending up mostly in the partner's pockets rather than wisely invested, and the employees who work at these doomed companies. The LPs are in a position to complain and/or sue, but they may not be actively managing their money. In that case, their money will just go on hurting people. Sad.

Having capital turns out to be a big responsibility. It can do a lot of good if well-invested, or a lot of harm if badly invested.

Providing services to other portfolio companies or otherwise related partners in of itself is not a bad practice, but can have many benefits for all parties involved.

Having said that, it should always be the CEOs and senior managements responsibility to do their due diligence to evaluate any service their business depends on so heavily and regularly renegotiate.

There's a good reason a Apple, Snap, Netflix etc. are using both Google and Amazon's cloud services to be in a position to leverage their relationship to negotiate better deals and not be dependent on a single provider.

Yes portfolio companies can offer services to each other for commercial rates. I think the issue here might be outlined here: "They charged over half of the total “investment”, hundreds of thousands of dollars, for an app one guy could have built in 2 months."

If they are being sold a service for an inflated price then there could be grounds for charges. This could be a way to move money from one company to another.

One fund could be doing very well and the VC might be in carry whilst another is doing poorly. So if you're the VC you'd want to move money into the more successful fund to generate better returns and higher carry (i.e. 20% of the profits after fees).

Portfolio companies using other portfolio companies for various reasons is really common. Sometimes it's that they give discounts or freebies to each other. Sometimes it's some personal preference or relationship of the VC giving a favor. It's not necessarily nefarious.

This exact thing just happened on the latest episode of Silicon Valley with Eklow Labs.

http://www.vulture.com/2018/04/silicon-valley-recap-season-5...

I would say it's more common than people want to admit.

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