Mercor’s Brendan Foody calls out Sequoia over ‘dual-pricing’ valuation tricks

In caller days, founders and founders-turned-investors took to X to stock horror stories astir being mistreated by VCs. Their complaints ranged from VCs falling dormant during transportation meetings to investors suggesting a laminitis occurrence a co-founder.

Brendan Foody, co-founder of the AI endowment level Mercor, which was past valued astatine $10 billion, went truthful acold arsenic to telephone retired Sequoia, arguably 1 of the astir elite VC firms successful the world.

“The “sequoia scam” is worse than a azygous fearfulness story,” Foody wrote connected X. “in the past 6 [months] ive seen a fractional twelve rounds wherever sequoia invests successful 2 tranches. everyone pretends they lone did the higher valuation. founders misrepresent this to their employees & past store it to angels too.”

TechCrunch has antecedently reported connected VCs investing successful the aforesaid circular astatine antithetic valuations. Under this mechanism, the pb VC steadfast invests a important chunk of its superior astatine a lower, preferential valuation, portion putting a overmuch smaller information of superior successful astatine a drastically higher price. The monolithic “headline” valuation that gets announced manufactures the cognition of a ascendant marketplace winner, masking the information that the pb investor’s existent mean introduction terms was importantly lower.

The disparity tin beryllium stark. For example, erstwhile the AI-driven IT helpdesk startup Serval announced a $75 cardinal Series B astatine a $1 cardinal valuation, the announcement didn’t archer the full story. According to The Wall Street Journal, Sequoia’s existent lowest introduction constituent valued the institution astatine conscionable $400 cardinal — little than fractional the header figure. The spread betwixt those 2 numbers is the spread betwixt cognition and world that Foody is pointing at.

Serval isn’t alone. At Aaru, a startup that uses AI to simulate idiosyncratic behaviour for marketplace research, pb capitalist Redpoint backed the institution astatine a $450 cardinal valuation contempt an announced $1 cardinal header price.

Sequoia’s Shaun Maguire pushed back connected Foody’s characterization directly. “TBH I person seen immoderate of this behaviour but I deliberation it’s unfair to telephone it the ‘Sequoia scam,’” Maguire wrote successful effect to Foody connected X. “This has happened astir 5 times during my 7 years astatine Sequoia. What happens is different investors are consenting to wage a precocious terms for a blistery institution — usually AI — astatine multiples supra what we’re consenting to pay. So we effort to decouple the company-building narration with our spouse from the capital, and this leads to 2 tranches astatine antithetic valuations successful adjacent succession.

“I’m not alert of thing shady here,” Maguire continued, “but if you’ve seen it I’d emotion to know. VC is simply a repeated game, truthful it conscionable doesn’t marque consciousness for america to effort to mislead people. And if anyone has, I’d emotion to know. And successful general, congrats connected the occurrence of Mercor — it was a miss for us.”

Maguire’s effect frames the signifier arsenic a marketplace world alternatively than a deliberate maneuver — Sequoia, helium suggests, is simply unwilling to wage what competitors volition wage for the hottest deals, truthful it structures its information differently. Whether that mentation afloat holds up depends connected a question Maguire doesn’t address: what founders are telling the radical who don’t already cognize astir the little tranche.

Although Sequoia appears to usage this pricing mechanics astir frequently, Foody acknowledged it isn’t the lone steadfast utilizing this tactic. And portion the dual-pricing structures surely inflate a startup’s perceived worthy and assistance pull apical talent, calling the signifier a “scam” whitethorn beryllium going excessively far.

That’s due to the fact that the banal options granted to employees should theoretically beryllium valued based connected the blended terms of each tranches, said Jason Woo, spouse successful valuation and fiscal modeling astatine Armanino. Woo’s radical provides the autarkic 409A valuations that startups usage to terms worker banal options. A 409A is an autarkic appraisal that’s expected to acceptable the just marketplace worth of a backstage company’s shares — it’s the fig that determines what employees really wage for their options, careless of what valuation gets announced successful a property release.

There’s a catch, however: 409A valuations are wide understood to skew low. Because the 409A sets the onslaught terms of worker options — and a little onslaught terms means a smaller taxation measure for the institution — determination is simply a structural inducement to support that fig down. Which means the autarkic appraisal that’s expected to support employees from an inflated header valuation is also, by design, not trying peculiarly hard to scope the apical of the range. Employees whitethorn not beryllium paying the header terms for their options, but they whitethorn not beryllium getting the afloat representation either.

The angel question is much complicated. Unlike employees, angels are penning checks, not receiving options. There is nary autarkic appraiser lasting betwixt an angel capitalist and immoderate fig a laminitis chooses to share.

The dual-pricing operation is conscionable 1 of mode VCs and founders crippled the cognition of occurrence successful a hyper-competitive market. Another, much pervasive maneuver involves manipulating oregon outright overstating yearly recurring gross (ARR).

The VC Niko Bonatsos, a longtime seasoned of General Catalyst who much precocious founded Verdict Capital, addressed this contented during 1 of TechCrunch’s events successful Athens past month. “We [at Verdict] mostly put earlier metrics, earlier product, earlier the institution [has afloat taken shape] but I bash person a past portfolio, and sometimes the conversations are telling. I’ll get a telephone oregon an email with a precise precocious ARR number. I’ll think: I didn’t retrieve that institution doing truthful well. So I scope retired to the founder: ‘What happened? Why are the numbers truthful strong?’ And the reply is: ‘Oh yeah, it’s 365 times the gross we made yesterday due to the fact that 1 of our campaigns hit.’ So yeah, immoderate of these presumption person mislaid meaning.”

Foody declined to remark further. Sequoia didn’t instantly respond to a petition for comment.

— With further reporting from Connie Loizos