VCs’ job is to value companies. They should stop LARPing about “value add”, “deal flow”, and “access “.
Public-market investors are comfortable telling you what they do: buy stocks low and sell them high. But Venture Capital investors who do the exact same thing — buy equity in startups at what they think is a low price, and exit higher — seem much less comfortable talking honestly about their job. When they talk to founders and LPs, they pretend to be something they’re not. I call this VC LARPing.
“Value Add” is LARPing
VCs act like offering non-monetary value is a big part of their job. VCs will try sell you on value-adds like:
- Help raising follow-on funding from other investors
- Help with recruiting
- Help with marketing
- Help with product design
- Connections to influencers
Sure, a VC adds some value beyond their money. But the value-add illusion cracks when, instead of treating it as priceless, you ask yourself to quantify how much it’s worth.
Stalin observed that “quantity has a quality all its own”, and this is true for VC value-add. If you want a specific type of value-add, all you need to do is raise a larger quantity of money. You can use money to purchase the specific thing you need.
The reversal test
Let’s flip the situation around and apply the reversal test. Imagine you’ve already raised $10M from a no-name VC, DumbMoney Capital. A week later, you hear that Sequoia is considering acquiring DumbMoney VC and making it part of Sequoia. You call up Sequoia and say “Hey, I would love to have Sequoia on my cap table. Is there anything I can do to convince you to go through with your acquisition of DumbMoney VC?” They say, “Sure, we’re willing to do it, but we’re not sure if it’s worth it. If you sweeten the deal for us, we’re willing to do it.”
“Uh, okay, sweeten the deal how?”
“Pay you? How much?”
“A million dollars”.
WHAT? You’re going to wire Sequoia $1M just so they can offer you some advice and connections from time to time? This is a ridiculous offer.
But… flip the situation back around. This is exactly what Sequoia is saying when they say you should give them favorable terms in your funding round, that you should accept 20% less money than the lower-tier VCs, for a given percentage of equity because they’re “smart money”. It’s not prudent for you as CEO to write a $1M check without understanding exactly how you’re going to get your money’s worth, because most of the time you’ll be overpaying.
VCs talk a lot about their reputation. Reputation is a big part of the amorphous “value-add” concept. Sequoia, for example, has made tons of money by making smart choices about which startups to invest in. Because of this, they’ve earned a great reputation as a “Tier 1” VC.
Who wouldn’t want to brag that Sequoia is on their cap table? Doesn’t having that “Tier 1” name inspire confidence when you’re trying to sell employees on your company, partners, other investors, etc?
Sure. But you have to quantify how much it’s worth, which is a very finite amount. If you want to hire a great employee, don’t give up $1M of cash that you could have in your bank, just so you can brag about your VC’s reputation. That would be overvaluing Sequoia’s reputation. There are better ways to deploy $1M to attract top-tier employees, such as using it to pay higher salaries for those employees.
Board Stewardship is LARPing
VCs will try to convince you that you should take their money because they’ll be a great board member for you, while if you take money from someone else, you’ll end up with someone greedy and incompetent on your board.
Sure, if you have to pick a VC to go on your board, you should definitely choose a good VC over a bad one. But if you’re pondering which VC to add to your board, you’ve already been tricked into “thinking past the sale” and accepting the premise that selling equity in your company requires adding a VC to your board.
Why do VCs want you to give them a board seat? So that they can use that power to make decisions that serve the interest of the VC, in opposition to the interests of the founder, and even in opposition to the interests of the company.
But why should VCs expect you to agree to give them a board seat? Frankly, they shouldn’t. The founders should choose the best board members for the company they want to build, without constraining their choice to a VC. If the founder happens to choose a VC, to choose the same person who invested in their company, great. But let’s not conflate two very different VC functions: valuing whether a company is well-priced, vs making decisions about how to run a company. VCs should stick to the former.
In other words, VCs should invest if and only if they think the founder’s company, managed by a founder-selected board, is a good investment for the price.
So far we’ve talked about how VCs are LARPing to founders. Now let’s talk about how VCs are LARPing to their limited partners (LPs). VCs are desperate to justify to their LPs why they’re taking a 2%/yr management fee and 20% carry. Ideally, they’d just make a case for their superior abilities to identify startups that are attractively priced. But since those core abilities are so often weak or nonexistent, VCs resort to LARPing once again.
“Deal Flow” is LARPing
VCs tell their LPs that they have a “deal flow” advantage. Supposedly, they “see more deals” than other VCs, because the best founders reach out to them and not to others. Sounds plausible, but take a moment to think about it… do you see any problem with this claim?
The best founders understand that they’ll get the best fundraising terms if they create a bidding war with as many participants as possible. Aaron Harris advises founders to “approach every fundraising as an auction”.
Aaron was a partner at Y Combinator, which is known for hosting Demo Day, which is a direct attack on the concept of proprietary VC deal flow. All VCs are looking at the same list of YC companies before and during Demo Day. There’s no proprietary deal flow. To the extent that non-YC companies are still hard to identify, that’s a temporary advantage, a relic from a time when startup fundraising was a niche with a small number of gatekeepers. It’s not relevant in the context of a large abundant capital market, which is what we have today, and what we’ll always have in the future.
“Access” is LARPing
One of VCs’ favorite claims is that they have superior “access to deals”. The claim is that founders will take their money more than the competition’s money, because they (the VC) have a strong reputation of adding value and being founder-friendly.
But actually, the whole concept of “access to deals”, to the extent it’s even a meaningful claim, isn’t something to be proud of. It implies that the VC is siphoning value away from founders who don’t know better.
Let’s say Hotshot Capital and DumbMoney VC both offer term sheets of a $10M investment at $50M post. Hotshot Capital wants its LPs to think it has better “access” in situations like this; that the founder will take their term sheet over DumbMoney’s term sheet. But wait, what if DumbMoney raises their offer to $11M at $55M post? In that case, taking DumbMoney’s offer is equivalent to taking Hotshot’s offer and then getting an extra free gift of $1M cash deposited into the company’s bank account.
DumbMoney should be able to win this deal by raising its cash bid. So what happened to Hotshot’s “access”?
If a founder is smart enough to assign an overall numerical price to two term sheets, quantifying all the factors including board structure, employee equity pool dilution, VC’s advisory value-add, etc, then the founder will tell DumbMoney how much extra cash they need to add to their offer in order to beat Hotshot’s bid, and it won’t be much more than $1M.
Therefore Hotshot is kidding its LPs by claiming “access” as a serious advantage. The only time “access” works is on gullible founders who think they shouldn’t shop around Hotshot’s term sheet. I wouldn’t call that “access”, I’d call that gaslighting founders into having a below-market self-worth.
The Non-LARPing Future
The non-LARPing part of a VC’s job is valuing startups. Valuing a company is a valuable contribution to society. It’s allocating society’s capital to the startups who will use it the most effectively to yield the highest returns. And it compensates the VC handsomely for their effort.
VCs love talking about supporting founders. Well, if you want to support founders in an authentic way that’s actually in your job description, in such a way where incentives are aligned rather than a fake LARPing display, then just focus on being a good investor: identify a startup’s potential for success and bid for the chance to invest, thereby raising the company’s valuation.
The clock is running out on how much longer VCs can keep LARPing, because early-stage startup funding is rapidly changing from a restricted activity into a free and liquid market.
We all know what a free and liquid market looks like: it looks like the public equity market. For instance:
- When you want to buy a public stock you just look it up, see what the market price is, and buy it if you think it’s worth more than that price. There’s no question of whether you have “access” to the trade.
- When you buy equity in a public company, you might be a helpful value-added investor to that company, but that doesn’t change the price you pay for its shares. If you want to get compensated for your value-add services, you make a separate contract.
- When you buy a public stock, you can sell it any time. You’re not forced to hold it for years.
The market for startup equity is becoming more free and liquid:
- The invention of the SAFE note has empowered startups to engage in “high-resolution fundraising”, selling their equity to one investor at a time without the need to coordinate a single “lead investor” who sets fixed terms for a large “round”.
- General Solicitation and equity crowdfunding up to $5M have recently been legalized in the US. On sites like OurCrowd and SeedInvest, companies can broadcast their fundraising pitch to millions of individual investors, completely eliminating any deal flow advantages that VCs might claim.
- AngelList syndicates allow startups to broadcast their pitches to thousands of accredited investors, who can then invest with just a couple clicks, as easily as investing in stocks on Robinhood.
- CartaX is helping startups run secondary auctions to help shareholders liquidate their holdings whenever they want.
Startup investing will ultimately become as free and liquid as public-market investing. There will eventually be a single place where you can look up any startup, see its price ticker, and trade on it.
These trends are sure to continue because they benefit everyone except for the VCs who are focused on LARPing rather than on valuing companies. So while VC LARPing is common today, it won’t be for much longer.
I’ve been picking on VCs, but you know what, founders are guilty of LARPing too: 80% of startups don’t even have a coherent value prop.