Mercor’s Brendan Foody calls out Sequoia, accusing it of

Brendan Foody, co-founder of the AI talent platform Mercor, has publicly accused elite venture capital firm Sequoia of engaging in "dual-pricing" valuation tactics, sparking a fresh debate over transparency in startup funding. Foody alleged on X that Sequoia invests in two tranches at differing valuations, often leading founders to misrepresent the higher "headline" figure to employees and angel investors, creating an inflated perception of success. This controversial practice, Foody claimed, has been observed in "a half dozen rounds" over the past six months.

Foody's direct challenge comes amid a broader trend of founders and investors taking to social media to share negative experiences with VCs. His specific critique centers on a mechanism where a lead VC firm commits a substantial portion of its capital at a lower, preferential valuation, while a smaller sum is invested at a drastically higher, publicly announced price. This "headline" valuation can then be used to project a dominant market position, obscuring the lead investor's actual, significantly lower average entry price.

Dissecting the Dual-Pricing Mechanism

The disparity between these valuations can be considerable. For instance, the AI-driven IT helpdesk startup Serval announced a $75 million Series B round at a $1 billion valuation, led by Sequoia. However, The Wall Street Journal reported that just days earlier, Serval was valued at under $400 million in a Series A extension in which Sequoia also participated. This stark contrast highlights the gap Foody describes between market perception and reality. Serval is not an isolated case; Aaru, an AI market research startup, saw lead investor Redpoint back the company at a $450 million valuation despite public announcements of a $1 billion headline price.

Sequoia partner Shaun Maguire promptly responded to Foody's allegations on X, pushing back against the "Sequoia scam" label. Maguire acknowledged seeing similar behavior approximately five times during his seven-year tenure at the firm. He explained that other investors are often willing to pay significantly higher prices for in-demand, typically AI-focused companies, than Sequoia is. To maintain its relationship with the company while not overpaying, Sequoia structures its participation with two tranches at different valuations in close succession.

Maguire maintained that he was "not aware of anything shady here," framing the practice as a pragmatic response to market dynamics rather than an attempt to mislead. He emphasized that venture capital is a "repeated game," suggesting it would be counterproductive for firms like Sequoia to intentionally deceive. He also commended Mercor's success, noting it was "a miss for us." Maguire's defense positions the firm as adapting to competitive market realities, though it doesn't fully address what founders communicate to those unaware of the lower tranche.

Implications for Employees and Angels

While Foody acknowledged that other firms also employ dual-pricing, and the tactic can indeed boost a startup's perceived worth and talent attraction, classifying it as a "scam" might be an overstatement. This is partly due to the mechanism designed to protect employees: stock options are theoretically priced based on the blended value of all tranches, not solely the headline figure. Jason Woo, a partner at Armanino specializing in valuation and financial modeling, explained that independent 409A appraisals are used to establish a company's fair market value for option pricing, insulating employees from inflated public valuations.

However, a critical caveat exists: 409A valuations are widely known to lean low. Companies have a structural incentive to keep strike prices down, as a lower price translates to a smaller tax burden. Consequently, the appraisal system, while intended to safeguard employees, may not vigorously pursue the highest possible fair market value.

The situation for angel investors is more complex. Unlike employees, angels are direct capital providers and are not shielded by independent appraisals. Their investment decisions often rely directly on the valuation figures shared by founders, which could easily be the higher, publicly announced headline number.

This dual-pricing structure is just one among several methods VCs and founders utilize to manage the perception of success in the highly competitive startup landscape. Another prevalent tactic involves manipulating or exaggerating annual recurring revenue (ARR). Niko Bonatsos, formerly of General Catalyst and now founder of Verdict Capital, recently highlighted this issue at a TechCrunch event. He recounted instances where founders would present unexpectedly high ARR figures, only to clarify that the number represented 365 times a single day's revenue from a particularly successful campaign, underscoring how certain terms have lost their original meaning.

Brendan Foody declined further comment on the matter, and Sequoia did not immediately respond to TechCrunch's request for comment. The ongoing dialogue underscores the persistent challenges in fostering transparency within venture capital valuations.

FAQ

Q: What is "dual-pricing" in venture capital? A: Dual-pricing refers to a venture capital investment strategy where a VC firm invests in a company at two different valuations within the same funding round or in quick succession. Typically, a larger portion of the investment is made at a lower, preferential valuation, while a smaller portion is attributed to a much higher "headline" valuation that gets publicly announced.

Q: How might dual-pricing affect employees and angel investors? A: For employees, stock options are theoretically priced based on an independent 409A appraisal, which should reflect a blended valuation and protect them from inflated headlines. However, 409A valuations often skew low due to tax incentives. For angel investors, who directly provide capital, there's no independent appraiser, making them potentially more susceptible to relying on the higher, publicly announced valuation shared by founders.

Q: Is Sequoia the only firm accused of using this valuation strategy? A: While Brendan Foody specifically called out Sequoia and a partner from the firm responded, Foody also acknowledged that Sequoia is not the only firm utilizing this dual-pricing tactic within the venture capital ecosystem. The practice highlights a broader trend in a competitive market.