Finding The Last Sucker To Invest

from the how-the-game-is-played dept

Valleywag points us to a rather scathing profile of late stage "investment" firm Advanced Equities in Chicago. Valleywag refers to the operation as a venture capital firm, but the details suggest it's a bit different than a traditional VC firm, which tends to raise a fund and then invest it as deals come up. Instead, it looks like AE is more of an investment hunter. While it does appear to have some money under management, it sounds like other VCs come to AE to go out and find investors to invest in the latest round. Tellingly, rather than referring to these investors as "limited partners" like a regular VC firm, AE refers to them as "customers." And, from the Forbes story, it sounds like those "customers" are basically unsophisticated investors who don't recognize what they're getting into.

Rather than billionaires, say former AE brokers, many clients are doctors, lawyers and dentists who lack the sophistication of typical institutions and ultrarich VC investors.

As an example, they cite one such case:

In 1999 AE sold Constance Kamberos, now 82, $330,000 worth of "bridge" notes issued by Hymarc, a firm it backed. Kamberos says the notes were pitched as a relatively safe way to earn a 12% yield. When she didn't get paid by Hymarc, Kamberos visited AE in Chicago's Loop. After she had a heated exchange with Daubenspeck, AE had the cops haul her away, Kamberos says (AE says she visited repeatedly and was hauled out by building security)

These aren't stories you hear with a typical VC firm. These sound more like stories you hear from "boiler room" operations tricking unsophisticated investors out of their hard-earned savings. Yet, as Forbes notes, big Silicon Valley VC firms like Kleiner Perkins and NEA love to talk up AE. Hmm. Then, let's recall that the IPO market has pretty much dried up for startups lately, and you can start to put two and two together.

In the bubble years, the "business model" of certain venture backed startups, was basically to sell equity to the last sucker. In the late 90s that was the public market -- consisting of a bunch of unsophisticated retail investors who would overpay for junk. But it's harder to get access to the public markets, and at least a few of the suckers have learned at least some of the lesson. However, if you can convince those suckers that they're getting in on a special deal -- say a "late stage, pre-IPO startup backed by the biggest names in Silicon Valley" the lessons learned from the last bubble go out the window. Reading this, it would appear that AE's function is to bring those "last suckers" to these startups and their VCs without going through the painful public market IPO process.

What's not clear is whether or not the VCs (and startup founders?) are taking money off the table directly during these late stage financings -- but it wouldn't be all that surprising (such deals are increasingly common these days). And, it would explain situations like the one in the Forbes article where AE helped gather up $45 million from "customers" to invest in a company called Agami. Five months later, the company no longer existed. Even people who worked at the company had no idea what happened to the money. The Forbes piece also notes that AE often pumps up the valuation of the startups in question, meaning that an earlier stage VC could be selling its shares as part of that "investment" (i.e., the money would go straight to the earlier investors, rather than the company), allowing them to still get a positive ROI on a company about to go broke.

If the Forbes report is accurate, then it certainly sounds like VCs may have figured out a different way to find that "last sucker" it needs to cash out certain investments without having to take a company public. It doesn't necessarily sound illegal (though that may depend on the details -- and there are apparently a bunch of lawsuits floating around AE). Never underestimate the ability of early stage investors to eventually find a bigger sucker to take their bad investments off their hands.

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