The entire model attracts the kind of "consultants who give advice" you describe. After all, people who want to get their hands dirty, i.e. people who are a good fit with startups, are overwhelmingly going to want to work directly for said startups.
We also had this super weird mismatch with perceived value. The operational VC "billed" agency-style, so by the hour, at (to us) outrageous hourly rates. It was like 6x what we'd pay a salaried employee doing the same work. We didn't "feel" it as bad because it cost us equity, not money. But we'd have never hired that agency for that money, if it was cash. The moment we realized that this was the case, we stopped the collaboration. It was a costly distraction and nothing more.
I'm curious if Hoffman found a way around this, but I don't see it in this article.
This kind of pricing, when implemented, is a clear case where the interests of the startup and the VC are misaligned. It's up to the founders to recognize that the "operational VC" model is a bad deal for themselves, and reject it accordingly.
That's only assuming he doesn't understand the VC model, which I doubt. The extremely power-law nature of VC investments means he can get better returns if he maximizes the growth trajectory of his portfolio companies, than if he maximizes the size of his share (by billing at high rates, i.e. at the cost of potentially less steep growth). Unless he's a moron, he'll genuinely want his sweat investment to cause tremendous growth more than anything else.
I think that the incentives are aligned as much as they are with cash VC investments (i.e. closely, but not entirely, because the founder has all their eggs in a single basket and the VC doesn't). I just think he can't pull it off. :-)
But back to the billing: it is in the VC's best interest to acquire the largest possible percentage of the company at the lowest possible cost. When the VC is investing "services" instead of cash, and has control over the pricing of the services, it would be in the VC's interest to provide a smaller quantity of services in exchange for the same amount of equity, since this decreases the VC's cost of investment.
You're right that it would not make sense for the VC to make a deal that is egregious enough to choke the company's growth, since that would diminish the value of the equity, but rational VCs would not intentionally make such a deal. Also, since the services in this arrangement cost the company equity, not cash, I think overbilling would only hurt the company through opportunity costs (as the equity could have been used to obtain a better offer).
Whether it makes sense for the VC to overbill for services also depends on how much equity the VC owns. Most of my above comments operate under the assumption that the VC owns a small percentage of the company.
This is a good point that I had not considered yet. Thanks, I agree.
I've been on the other side of this with a few startups, and the right answer is almost never to come in and drop a bunch of code as much as founders would like an extra set of hands.
A good SME can come in and have a solid whiteboard session with a team to shave off the first two iterations of development. I've done this before from a security perspective where just making the developers aware of the sharp edges and being available to answer questions was a massive force multiplier.
We had a VC pull this garbage once. Although it wasn't for equity. They just offered it as a service "at cost".
We dropped their $90/hr Manhatten based book keeper and $800/hr attorney just as quick as we could without ruffling too many feathers.
I think that's moderately useful - doing the work on building financial models or finding operational hacks to solve specific problems can be helpful, and isn't really a thing where it is annoying bringing a person up to speed only for them to leave.
No way. Assuming a 4 year investment that's lower pay than a low risk bigcorp job.
This is a little bit disingenuous, because I’m pretty confident outside the 10% best case, there’s a pretty broad distribution where you work long hours and come away with SOME return, so I suspect the expected return may be close to even for passionate founders, albeit probably with more stress in the overall effort.
Of course, the people starting companies usually aren’t guessing they have a 10% chance of success; you need to believe you’re an outlier to be successful in the startup game, it seems to me.
Historically, the problem is that VCs tend to send "subject matter expert" type consultants who give advice. Startups need someone to do the work more than they need someone to give the advice. The VC-provided talent usually generated more work than they solved with questionable returns for the company.
Unless Reid Hoffman has cracked the code of sending the right people to get work done, I'm suspicious.