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By Margaret Popper in New York
FEBRUARY 3, 2000

The Confusing Agenda of Consultant VCs

They want their proteges to be clients as well as investments


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Finance Archive is about as bland a concept as you'll find on the Web. It helps consumers compare home appliances. Yet the company is the product of a controversial new trend — consulting firms turned venture capitalists.

Boston Consulting Group owns 19% of Brandwise. And their relationship shows the peculiar twist consultants bring to the private-equity game. First, BCG created the company with its client, Whirlpool Corp. The appliance maker had hired BCG to devise an Internet strategy and study how consumers compare products. From BCG's research, Brandwise was born. Sixteen BCG consultants ran the baby for eight months until Cathy Misunas, former head of the airline booking system, SABRE, took over as CEO. Most venture capitalists manage their proteges actively. But they delay their payoff till they sell their stakes. Not BCG. It charged Brandwise several million dollars — by the hour — for its nurturing. The result? BCG got a good chunk of cash back long before any "liquidity event" — a sale or public-stock offering — and it kept the equity.

Welcome to venture capital — consultant style. It's a world of mixed, sometimes conflicting, agendas. Independent VC firms have a fairly straightforward mission: Buy low into untried companies, ramp them up fast, and sell very high. But some of the consultants' priorities are far removed from those of most conventional VCs or entrepreneurs. Their proteges are as much captive clients and labs for honing e-commerce skills to sell to their traditional big-company clients as they are investments. "There are really four motivating factors for doing this," says David Pecaut, head of the global e-commerce practice at BCG and its venture-capital efforts. "The first is an alternative for our existing clients: Through a partnership with us, they can explore e-commerce possibilities. The second is to ensure our leadership in e-commerce consulting. The third is retention of our own talent [by giving staff startup experience]. Really, the last is the financial returns." Venture investing is almost an accident of his firm's normal activities, insists Booz, Allen, Hamilton consultant Harry Quarls: "I have to be in dot.coms for credibility and brand strength. But dot.coms don't have cash. They've forced consultants to take equity."

Consultants are certainly gung-ho about their venture adventures, and who wouldn't be, given the returns on VC investments in recent years. BCG already has stakes in seven e-commerce startups (including Brandwise) and an incubator. It plans to invest in 20 companies a year for the foreseeable future. In December alone, consulting firms unveiled new funds with nearly $3 billion to invest — $1 billion from Anderson Consulting, $1.5 billion from EDS, and $300 million from PricewaterhouseCoopers. At that rate, consultants could fast become a significant source of private equity. (Total U.S. venture investment probably doubled last year to at least $30 billion.)

TIES THAT BIND? So far, few consultants fund companies with no ties to them. Some they create, such as Brandwise. Others come to the firms as clients. BCG only takes business plans from clients and staffers, at this point. But consultant VCs will likely want to cast their nets more broadly. After all, they have a lot of cash to invest — some of it with conventional VCs, who will presumably bring in outside deals. Andersen Consulting Ventures already accepts proposals from unaffiliated entrepreneurs.

As VCs, big consultants have two strong suits — high-quality manpower and superb corporate connections. But they might not be the best partners for entrepreneurs, especially at a time when so much VC cash is available. For one thing, their desire to extract consulting revenues from their proteges puts them at odds with the startup culture. That's what entrepreneur Chase Franklin found after Andersen Consulting Ventures took a stake in his company, Qpass, a Seattle-based micropayment processor. Andersen billed for its advice at its standard rates, or close to them. "On average that's a 50% to 60% greater cost than if we hired someone ourselves to do the same job," says Franklin. "This is philosophically and economically in opposition to the culture of a startup which is all about preserving precious capital — minimizing cashflow expenditures to maximize equity returns."

He found the consultants' methodical style especially galling because it translated into more fees. "Time and again, we saw the consultants blink at the last second," says Franklin. "They'd decide to do another analysis and add a couple of hundred pages to the specs." The tension led to boardroom showdowns between Franklin and Andersen on a number of occasions. Overall, the relationship has proved fruitful, say both Franklin and Jack Wilson, the head of Andersen Consulting Ventures and a Qpass board member. Andersen, after all, contributed valuable technology and hooked Qpass up with American Express, now an investor and prime client. And the consultants did catch on to the startup ethos, says Franklin.

EYE ON THE CLOCK. As for Qpass, its managers learned one trick to getting good value from a consultant investor: Watch the meter constantly. Entrepreneurs who accept consultants' money can't reject their pricey help out of hand. But they needn't be completely passive either, especially if they come to the table with an already formed company. "If Andersen can offer you the specific skills you need at a rate of $300,000 per year, and you only need them for a couple of months, it's easy to say 'I'll use them,'" says Franklin. "But if you don't manage it properly, nine months later you'll find yourself with a bill for a quarter of a million dollars." Consultants are sensitive to the cost issue, but they typically invest in well-funded operations with strong prospects that can afford and appreciate their help, says BCG's Pecaut. "They are willing to pay what it takes to get out of the starting gate early," he notes.

What of the other sensitive point for entrepreneurs: that consulting partners' eagerness to capitalize on their newfound Web savvy with bigger clients will somehow hurt their proteges' competitive position. Consultants insist that they are old hands at managing clients with competing interests, and any shared information will be generic. "What we do to build a knowledge base is to do our own research on e-commerce that can give us general insights into the way the business functions," says BCG's Pecaut.

Still, the concerns linger. "BCG is very intent on learning from the startup experience, and what we're going through," says Cathy Misunas, CEO of Brandwise. "I'm not sure how they'll go about transferring this knowledge in practice." As part-owners, advisors, and sellers of services, consultants clearly have divided loyalties. That's something entrepreneurs have to keep in mind when they take their money.


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