In recent days, founders and founders-turned-investors have visited X to share horrifying stories of abuse at the hands of VCs. Their complaints range from venture capitalists falling asleep during pitch meetings to investors suggesting that founders fire co-founders.
Brendan Foody, co-founder of AI talent platform Mercor (previously valued at $10 billion), even singled out Sequoia, perhaps one of the world’s most elite VC firms.
“The ‘Sequoia Scam’ is worse than any single horror story,” Foudy wrote in X. “In the last six (months), I’ve seen six rounds where Sequoia invests in two tranches. Everyone is pretending that they just gave it a higher valuation. The founders are lying about this to employees and selling to angels as well.”
TechCrunch previously reported that VCs were investing in the same round at different valuations. Under this mechanism, leading VC firms invest a significant portion of their capital at lower preferential valuations, while investing a smaller portion of their capital at significantly higher prices. The huge “headline” valuations announced fabricate the perception of being the clear winners in the market and mask the fact that the lead investors’ actual average entry price was significantly lower.
Disparities can be significant. For example, when AI-driven IT help desk startup Serval announced a $75 million Series B led by Sequoia at a $1 billion valuation, the announcement didn’t tell the whole story, The Wall Street Journal reported. A few days earlier, the paper reported that the company was valued at less than $400 million as part of a Series A extension in which Sequoia participated, less than half the headline number. The gap between these two numbers is the gap between perception and reality that Foody points to.
Serval-chan is not alone. For Aaru, a startup that uses AI to simulate user behavior for market research, lead investor Redpoint backed the company at a valuation of $450 million, despite an announced headline price of $1 billion.
Sequoia’s Sean Maguire directly disputed Foudy’s characterization. “TBH, I’ve seen some of this behavior, but I think it’s unfair to call it the ‘Sequoia Scam,'” Maguire wrote in response to X’s Foody. “This has happened about five times in my seven years at Sequoia. What happens is that other investors are willing to pay many times more than we are willing to pay for the hot company (usually AI). So we are trying to separate the founding relationship with our partners from the capital, and this leads to two problems.” Tranches at different valuations occur in succession.
“I don’t know anything fishy here,” Maguire continued, “but if you’ve seen it, I’d love to know. VC is a recurring game, so there’s no point in trying to mislead people. If anyone knows, I’d love to know. And overall, congratulations on the success of Mercor. This was a failure for us.”
Maguire’s response frames this practice as a market reality rather than a deliberate ploy. Sequoia simply doesn’t want to pay what competitors would pay for the hottest deals, he suggests, so it’s structuring its participation differently. Whether that explanation holds true entirely depends on what founders are telling people who don’t already know about an issue Maguire doesn’t address: lower tranches.
Although Sequoia appears to be using this pricing mechanism, Foody acknowledged that it is not the only company using this strategy. And while a dual pricing structure can certainly increase a startup’s perceived value and help attract top talent, calling it a “scam” may be a stretch.
That’s because employee stock options should, in theory, be priced based on the blended value of all tranches, rather than a headline number, said Jason Wu, partner in valuation and financial modeling at Armanino (Armanino provides independent 409A valuations that startups use to set option prices). The 409A is supposed to reflect the company’s fair market value, giving employees an exercise price that is independent of the valuation announced in a press release.
There is a catch. It is widely understood that 409A valuations are skewed low. A lower strike price means a company has a lower tax burden, so there is a structural incentive to keep that number low. The valuations that are supposed to protect employees from soaring headline valuations do not, by design, take any special effort to reach the top of the range.
The angel’s question is even more complex. Unlike employees, angels write checks and do not receive options. There is no independent valuator standing between angel investors and the numbers founders choose to share.
Dual pricing structures are just one way VCs and founders test their perception of success in a competitive market. Another, more prevalent tactic involves manipulating or outright exaggerating annual recurring revenue (ARR).
Niko Bonatsos, a longtime General Catalyst veteran and venture capitalist who recently founded Verdict Capital, addressed this issue at one of TechCrunch’s events in Athens last month. “Most of the time we (at Verdict) invest in metrics and less in products and before the company is (fully formed), but I have a historical portfolio and sometimes the conversations speak for themselves. I think, “I don’t remember that company doing that well.” So I reach out to the founder and say, “What happened? Why are the numbers so strong?” That’s 365 times yesterday’s revenue because one hit. Yes, some of these terms have lost their meaning. ”
Foudy declined further comment. Sequoia did not respond to requests for comment.
— With additional reporting from Connie Loizos
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