VC Incentives: My $4M Write-Off, Co-Investor's $30M Gain

In the complex world of venture capital, the valuation of a startup can sometimes be a matter of perspective, heavily influenced by a VC's individual incentives. This reality was starkly illustrated recently when a prominent venture capitalist, operating under the SaaStr Fund, made his largest write-off to date: a $4 million investment reduced to zero. Yet, in a surprising twist, a co-investor in the exact same deal chose to mark up their investment from $15 million to a staggering $30 million. This dramatic divergence in valuation for the same company and outcome raises critical questions for founders about how VC incentives truly operate.

The “Acquisition” That Wasn’t Really an Acquisition

The company in question was “acquired” in an all-stock deal, with no cash changing hands. The acquiring entity was described as a “moonshot play,” a venture whose combined value might theoretically reach $100 billion someday. However, for the SaaStr Fund, this was not a viable argument. The underlying startup was effectively defunct, and the “acquisition” served primarily as a soft landing for its founders, designed to avoid negative press. Consequently, the SaaStr Fund made the principled decision to mark its investment down to zero.

In stark contrast, the co-investor viewed this same transaction not as an opportunity for genuine returns, but as a strategic opening for markups.

The VC Fundraising Game: When VCs Themselves Are Fundraising

The key to understanding this discrepancy lies in the venture capital fundraising cycle. The co-investor was actively raising their next fund, a process where portfolio valuations—or “marks”—play a crucial role. Limited Partners (LPs), who invest in VC funds, scrutinize metrics like Total Value to Paid-In (TVPI) and unrealized gains. A growing portfolio narrative is essential for attracting new capital.

Faced with the “acquisition,” the co-investor had a clear choice: either absorb the hit to their track record by marking the investment to zero just before fundraising, or inflate its value based on the theoretical worth of the received stock. Opting for the latter, they transformed a $15 million investment into a $30 million paper gain. This strategic markup bolstered their narrative, significantly aiding their efforts to secure the next fund.

Interestingly, the co-investor also voted in favor of this deal, despite its effectively zero-sum outcome for all parties. This decision was driven by the necessity of the acquisition to justify the subsequent markup.

How Incentives Actually Work in Venture

This scenario highlights a fundamental truth in venture capital: VCs, like any rational actors, respond to their incentives. When these incentives diverge from those of founders, the relationship can quickly become complicated.

Several common points of divergence include:

• Markups vs. Reality: VC firms have considerable leeway in valuing their portfolios. Without a central auditing authority, VCs under pressure to raise new funds have a strong incentive to be optimistic with their valuations. Those not actively fundraising can afford to be more realistic, even brutally honest.
• Voting for Bad Deals: VCs may support acquisitions or mergers that are detrimental to common shareholders if it creates a “paper exit” they can report. “We had an exit” sounds far better to LPs than “we wrote it off,” even if the financial outcomes are identical.
• The Fund Timeline Problem: The stage of a VC fund significantly influences its strategy. An older fund (e.g., 8 years old) needing to demonstrate returns might push for a mediocre exit, while a new fund with a 10-year horizon might encourage founders to take bigger risks, even when caution is warranted.
• Ownership vs. Outcome: Some VCs prioritize maintaining a high ownership percentage—for marketing or bragging rights—over maximizing the actual dollar return. This can lead to pressure on founders to avoid dilution, even when raising more capital is the best strategic move.

What Founders Should Know

Given these dynamics, founders must be proactive and informed when engaging with venture capitalists. Here are crucial considerations:

• 1. Understand Your VC’s Fund Cycle: Directly ask VCs about their fund’s age, when they expect to raise their next fund, and its current performance. A VC nearing a new fundraise will have vastly different incentives than one who just closed a fund.
• 2. Recognize That Marks Are Not Liquid: Internal VC valuations are often speculative. Treat any “paper” valuation with skepticism. The only valuation that truly matters is when cash changes hands through an acquisition or sale.
• 3. Observe Actions, Not Just Words: VCs may espouse “founder-friendly” or “long-term oriented” philosophies. However, their true alignment is revealed in their voting behavior—whether they support a challenging acquisition offer or back a down round to extend runway.
• 4. Diversify Your Investor Base: Having investors at different stages of their fund cycles can create healthy checks and balances. If all your VCs are at the same point, their incentives will likely align with each other, potentially at your expense.
• 5. Get Agreements in Writing: Verbal assurances are insufficient when incentives shift. Robust protective provisions, clear voting rights, and well-defined governance structures are essential for safeguarding your interests.

Accounting Can Drive Outcomes

After years in the venture capital landscape, it becomes clear that VCs are neither solely friends nor enemies; they are partners. However, these partners come with their own unique incentives, pressures, and fund dynamics.

The most successful VC-founder relationships are built on aligned incentives—when both parties are committed to building a generational company, when fund timelines match company timelines, and when the VC’s significant win is directly tied to the founder’s significant win.

Conversely, relationships falter when incentives diverge: when a VC needs a markup while a founder needs runway, or when a VC pushes for an exit while a founder requires more time and patience.

The $4 million write-off was painful, but the author emphasizes the importance of taking an honest zero over manipulating valuations to facilitate future fundraising. Ultimately, the only returns that genuinely count are those that deliver actual cash back to Limited Partners. Everything else, as the author concludes, is merely a story VCs tell themselves—and their investors.