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Should you pay your VC to ______ ?

August 7, 2008

Fill in the blank with anything including: conduct diligence, provide consulting or sit on the board.  Jason Mendelson from ‘Ask the VC’ was asked the following question last week:

My company is backed by VC firm to whom we also pay a $2k/month “consulting fee.” We have raised approximately $2MM from them in a Series A. Is that type of consulting payment typical in an early stage venture?

Jason’s answer was an unequivicol, NO! explaining, “I’ve never worked with a reputable VC firm that charges their companies to help them succeed.”  Several months ago I heard a rumor about a local venture capital ‘fund’ that was charging companies they were interested in funding a fee to conduct due diligence.  More recently I learned that an acquaintence of mine went to work for the ‘fund’ so I had a chance to ask, “Do you really charge for due diligence?”  The immediate answer was, “Yes, but if we decide not to do the investment the startup gets to keep the diligence.”  The acquaintence, who I really like, was dead serious and didn’t see the problem the practice.  I didn’t press too hard because the person just finished their MBA and this is their first job in venture capital (I hope they don’t read this post).

My stomach churned as I could imagine budding writers paying someone to ‘publish’ their book, or aspiring musicians paying someone to ‘produce their record’, or an inventor paying someone ‘evaluate’ their invention.  Of course, there are legitimate people in these businesses (and I suspect my acquaintance is legitimate), but I think it is a big mistake to do business this way.

Anyway, these sort of venture capitalists are taking two bites at the apple.  Venture capitalists shouldn’t take a fee from their investors AND a fee from entrepreneurs, ever.  Jason explains, “As a venture capitalist, we are paid a management fee by our investors that is our “salary” and we receive a percentage of the profits (called “carry”) on our fund.  We don’t get paid to sit on boards and certainly it is not appropriate for them to “round trip” your investment capital by paying themselves part of it. I would wager to guess if their investors knew they were doing this that the investors would revolt.”

Written by Alexander Muse · Filed Under Blog, Startups 

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