I recently heard mention by one VC of another and a firm that's been around for decades. The comments were appreciative, as the person had learned the trade at this company.

As I considered the affectionate comments, I had a start, as I realized I knew about the storied VC group from first-hand knowledge. It had been many years ago when I was associated with a publicly-held company, thinly traded, and privy to many of the ins and outs of strategic issues. So, while some are happily discussing the virtues of the venture capital industry, I though a look at the darker side might offer some good balance.

The VC, which will remain nameless for obvious reasons, seemed rapacious. Although a major investor in the business in question, some of its actions only enriched itself while draining money from the investment and leaving it in a precarious position.

For example, the business needed capital during a challenging period. I could have seen why a smart investor might have walked away, or limited its involvement. The VC firm was heavily invested already and held a board seat. It agreed to pony up the necessary capital under an unusual arrangement. It purchased some important intellectual property for the necessary cash and then licensed it back, in the IP equivalent of a lease-back deal, at usurious rates.

I don't remember the exact amount, but it sucked something on the order of at least a third of all top-line revenues for this important product line out of the business. The arrangement was effectively an imposed royalty rate that was beyond what a company in this industry could reasonably absorb. It also wasn't the only special arrangement in which additional money was provided at high cost.

The management team took the deals because it was desperate and, presumably, the other investors went along because they hoped to put off losing everything they had put in. So, why would a major investor put a portfolio company into a precarious position? I'd say that it owes to the nature of how VC companies work: 80 percent of the companies in their investment portfolio fail to return the invested capital. Only one out of every five will turn out to make money. The rest? Write 'em off.

From the VC's view, if one of these companies that is shaky, they might as well find a way to pull as much cash out as possible, because they know things are unlikely to go well. The company in question was already public, so there was no chance of using that as an exit strategy. (The ultimate tactic would be to sell off the old business after buying a new one under the company name and then, ultimately, sell that off to what was at the time a bottom-feeding large acquirer when a new management team wasn't able to make the necessary magic happen.)

What the VC does is to limit to the potential damage, and if an additional investment can keep things going long enough to pull out that extra capital and some more, why not? Yes, a VC wants the investment to succeed, but it knows the chances are slim and it has its own investors to consider.

When you accept investment money, you must, must, must understand the business strategy of the investor. Is it working a portfolio strategy in which most of the investments will go belly up? Is this an investor that likes longer-term relationships? Is there really actual value you can get from the VC's expertise, or is that just a come-on?

Remember, it's business, not something personal. The seeming friendship of the investor may not extend beyond how profitable a prospect you currently present, so assume it won't and go into anything with your eyes wide open. And protect your back.

Published on: Apr 23, 2015