Conflict of interest: VC’s investment in rival start-ups

Deal 1: Mohr Davidow (VC firm) had investment in Navigenics as well as 23andMe.

Deal 2: Andreesen Horowitz(VC firm) had investment in photo-sharing company Instagram as well as Picplz.

Deal 3: Softbank (VC firm) had investment in Snapdeal as well as Flipkart.

Deal 4: Softbank (VC firm) has investment in Ola (india), Uber(US), Grab(SouthAsia) as well as DidiChuxing (China).

What is common to the above deals? Well, same VC firm has invested in two or more direct rival start-ups. Last few years have witnessed, increasing number of such deals wherein VCs have invested in rival start-ups. This observation has hit me hard as I started thinking how does this deal impact the key stakeholders such as start-up founders, Regulatory bodies, the core market in which start-ups are fighting and of course VCs.

Let us briefly discuss how this may create an impact on various stakeholders;

For VCs: Head I win, Tail you loose! : One of the most important stakeholders in the above-mentioned scenario is VCs. For VCs investing in rival start-ups may be trendy now as bigger VCs are increasing placing these kind of bets. One obvious reason identified after interacting with a couple of VC advisors, is VCs are also looking towards reducing the risk of their bet going in vain. (call it “risk mitigation strategy”) It is like when there are few sizzling start-ups which are look-a-like in the same market & when you have no clue which one is going to be the next blockbuster just invest in all of it or majority of it so whichever is going to go up eventually you are more assured that it will make money for you!

For Start-ups: “Money Trap?” :For most of the start-ups, attracting the VC funding may look like the holy grail. But a brilliant research article by Pahnke, McDonald, Wang and Hallen (2014) published in Academy of Management Journal found that investment of same VCs in rival start-ups may impede the innovation at the start-ups and also there is opportunity and motivation for VC to leak competitive important information to other rivals in which same VC is invested. When VC is invested in rival start-up firms it may so happen that VC may force two rivals to merge or acquire as SoftBank(VC) being investor tried to do in snapdeal with flipkart and Uber with Ola in the Indian market. Irrespective of what start-up founders & core team believed or dreamt about, forced merger/acquisition may happen to the whims and fancies of some VCs. Like Uber sold it’s SouthEast Asian business to Grab.(another rival funded by Softbank) Time is ripe that start-ups do certain check-list before going after VC’s money.

Such as 1. VC background checks if it has a considerable investment in another rival start-up(s), 2. The inclusion of certain clauses in ‘term-sheet’ and then into a definitive agreement which is legally binding agreement, which restricts VC to some capacity to invest in other rival start-ups or restricting access to competitive and confidential information (trade secrets) if VC is invested/or planning to invest in a rival start-up. For a start-up, mad rush after VC funding without doing proper background checks on VC may create more problems than solutions. Many angels & VCs never indulge in such activities of investing in rival start-ups but it is better for a start-up to act smartly!

For regulatory bodies: “Perplexed & lost”: Imagine you have huge war-chest (money) which you use to invest considerably in two majors competing start-ups. Since both start-ups are losing money big time in order to retain and increase customers by giving away deep discounts or providing unbelievable promo offers at throw away price, eventually you as a key investor decide to merge both entities and create one big giant. Now the merged entity will bleed less (lower burn rate) due to no significant competition. Here, an act of VC to safeguard their own interest by trying to force two competing start-ups to merge is directly impacting the dynamics of the market. Role of regulatory bodies (Like competition commission of India) which are enforcing anti-trust laws becomes crucial for maintaining the fair competition in the market. Unfortunately, many times such bodies do too little and too late. Regulatory bodies have to remain very vigilant and action-oriented when many direct competitors in the same market are backed by the same set of investors.