Every day I’m surprised by a new announcement of a firm that invests in technology companies — doing something that must have serious conflicts of interest — and yet no one is saying anything about it.
**************
Examples:
(1) Crypto Funds
A16Z has a crypto fund AND a parent fund. If I was an LP in the main fund — I would be worried that the best crypto deals would only be done out of the crypto fund, and that I would be missing out on some of A16Z’s best opportunities. The firm has built a great rep in crypto. That may have been part of why I invested. And midway through the investment period I would have found out that the crypto deals would be done out of a separate vehicle that I may have had to invest MORE capital to participate in.
And what happens if the main fund does invest in a crypto company. Does that mean the crypto fund passed? Are there separate investment committees? What happens if both funds wanted to invest? Do they share the allocation pro-rata based on fund size? Is that fair?
(2) “Opportunity Funds”
These are funds that VC’s have set up to invest in growth opportunities that they see either within their existing early stage portfolios or from their connectivity in the venture community.
Question: what happens if the early stage fund still has dry powder (cash), and one of the best companies in the portfolio is raising a large follow on round? Does the early stage fund invest? In most cases, the VC firms earn higher fees on their earlier stage funds than they do on their growth funds. It’s actually better for the VC to invest out of the early fund than the later fund for that reason.
But some VC’s may realize their growth funds/opportunity funds are newer in their life — and they need to make sure the returns are good — maybe they give preference to their growth fund for that reason? And often those funds are bigger. So maybe the growth fund’s economics are better after all?
Or maybe they split the allocation? But at what ratio?
Or maybe the “early stage fund” only invests in Series A and Series B rounds. But how do you define a Series A round these days? That definition keeps changing.
(3) Direct Lending
Vista has set up a fund that makes corporate loans to technology companies — but what if it makes a loan to one of the companies in its equity fund? And what if the portfolio company breaks a lender covenant. Does the lending fund foreclose on one of the companies in the equity portfolio? Are the partners who manage the funds the same? (probably not). But do similar people share economics in both funds… probably. How do they make that hard decision?
And what if Vista wants to make a loan to a company backed by a rival private equity firm? Will that private equity firm let the Vista team invest? And get proprietary information on those companies?
(4) Mis-alignment of the Board of Directors
Let’s imagine a company is doing well — they are not worth $2B — and a firm offers them $150M of corporate debt. Maybe they could issue bonds (like WeWork or Uber did). The preferred equity holders would need to sign off on this.
On one hand — debt is cheaper than equity. This is better for the shareholders of the business, and I’ve written in the past about: “should technology companies be issuing corporate debt?”
But on the other hand, if the company takes in debt capital, the VC’s don’t get to keep investing more “expensive” equity into the business. And VC’s are already fighting for allocation in many cases. So they may vote “no” to a debt raise (even though they are on the board of the company and have a fiduciary duty to optimize capital raises) because it’s bad for their firms, and makes it harder to keep investing equity.
************
The traditional asset management world treats conflicts of interest very seriously. They have Conflict Committees and whenever things look sketchy — the Financial Times comes out with some big article about it.
For example: Apollo owns an insurance company, and it then took part of that insurance company’s assets and invested it into Apollo’s funds (or something like that). The reality is… the assets are performing and this was probably a commercially good decision. But it was controversial for a million obvious reasons:
But the technology world has been engaging in really tricky activity — and I haven’t really seen much mention around conflicts, and the potential perils. I wonder when that will change.
