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.
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.