Recently, founders and founder-turned-investors visited X and shared their harrowing stories of abuse from VCs. Their complaints ranged from VCs falling asleep during pitch meetings to investors suggesting founders fire their co-founders.
Brendan Foody, co-founder of Mercor, an AI talent platform recently valued at $10 billion, even mentioned Sequoia, one of the world’s most elite VC firms.
“The “Sequoia Fraud” is worse than a single horror story.” Foody wrote in “In the last six months, we’ve seen six rounds of Sequoia investing in two tranches. Everyone pretends they’ve got a higher valuation. The founders misrepresent this to their employees and then buy into the angels as well.”
TechCrunch previously reported on VCs investing in the same round at different valuations. Under this mechanism, major VC firms invest a significant portion of their capital at a lower preferred valuation, while also investing a much smaller amount of capital at a much higher price. The large “headline” valuations that are announced create the perception of dominant market winners, masking the fact that the actual average entry price for major investors was significantly lower.
The gap can be stark. For example, when AI-powered IT helpdesk startup Serval announced a $75 million Series B at a $1 billion valuation, the announcement didn’t tell the whole story. Sequoia’s actual lowest entry point values the company at $400 million, according to The Wall Street Journal. This is less than half the headline figure. The difference between these two numbers is the difference between perception and reality that Foody points out.
Serval is not alone. Redpoint, a major investor in Aaru, a startup that uses AI to simulate user behavior for market research, backed the company’s valuation at $450 million despite its announced headline price of $1 billion.
Sequoia’s Shaun Maguire directly refuted Foody’s characterization. “TBH I’ve seen some of this behavior, but I think it’s unfair to call it a ‘Sequoia scam,’” Maguire wrote in response to Foody on X. “This has happened about five times in seven years at Sequoia. What happens? Other investors are willing to pay prices many times higher than we are willing to pay for hot companies (mainly AI). So we try to separate the company-building relationships with our partners from the capital, and this leads to two spin-offs, with different valuations in succession.
Maguire continued, “I don’t know anything fishy here, but if you’ve seen it, I’d like to know. VC is an iterative game, so there’s no point in trying to mislead people. If anyone does, I’d like to know. And in general, congratulations on Mercor’s success. For us, it was a failure.”
Maguire’s response frames the practice as a market reality rather than a deliberate ploy. He suggests that Sequoia structures its participation differently because it is not willing to pay what its competitors will pay for the hottest deals. Whether that explanation is entirely valid depends on a question Maguire doesn’t address: what are the founders telling people who don’t already know about the sub-tranches?
Sequoia appears to use this pricing mechanism most often, but Foody acknowledged that it’s not the only company using this strategy. While dual pricing structures certainly inflate a startup’s perceived value and help attract top talent, calling this practice a “scam” might be taking it too far.
That’s because employee stock options should theoretically be priced based on the blended value of all tranches rather than the headline number, according to Jason Woo, valuation and financial modeling partner at Armanino, which provides independent 409A valuations that startups use to set option prices. The 409A must provide employees with a strike price that reflects the fair market value of the company and is separate from any valuation announced in a press release.
Here’s the problem: 409A valuations are widely known to be biased low. There is a structural incentive to keep that number low because a lower strike price lowers the company’s tax burden. Valuations that are meant to protect employees from inflated headline valuations don’t even intentionally try to reach the highest level.
The angel question is more complex. Unlike employees, angels write checks without receiving options. There is no independent evaluator between the angel investors and the numbers the founders choose to share.
Dual pricing structures are just one of the ways VCs and founders manipulate perceptions of success in a competitive market. Another, more widespread tactic is to manipulate or outright exaggerate annual recurring revenue (ARR).
Niko Bonatsos, a VC who is a long-time veteran of General Catalyst and recently founded Verdict Capital, addressed this issue at one of the TechCrunch events in Athens last month. “We (Verdict) primarily invest in pre-metrics, pre-product, companies (before they are fully formed), but we have a historical portfolio and sometimes we can tell through conversations. I get a call or an email with a very high ARR number and I think, I don’t remember that company doing that well. So I ask the founder, ‘What happened? Why are the numbers so strong?’ 365 times that.’ Yes, some of these terms have lost their meaning.”
Foody declined to comment further. Sequoia did not immediately respond to a request for comment.
—With additional reporting by Connie Loizos
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