Pulling back the curtain on vice clauses and investments in vice startups.
In August this year, the content subscription website OnlyFans was struggling to raise capital, in spite of its US$1 billion valuation. While OnlyFans is a unicorn sporting a high-profit margin, investors are not too keen on buying into the company. The reason why OnlyFans is having such a hard time finding investors is because of their not-safe-for-work (NSFW) image.
Vice clauses are restrictions imposed on where a venture capitalist (VC) fund can invest its money. These restrictions have forced OnlyFans to work on their image and ban sexually explicit content. Let’s dive deeper into vice clauses to understand how they can force a company to look for alternatives to its main revenue stream, and whether they need to be re-examined as time changes.
What are the restrictions imposed by a vice clause?
Before we learn what kind of investments are restricted under vice clauses, it is important to note that LPs are people or organizations who have put their money into VC institutions. This includes university endowments, corporate pension funds, sovereign wealth funds and wealthy families. While a VC typically does not have its own set of vice clauses, LPs do.
“A big LP will be like teachers’ unions or basically a teachers’ retirement fund… so you can imagine that a teachers’ retirement fund won’t want to be a large holder of Juul or a cannabis company,” says corporate attorney Bryant Smick. Vice clauses often stop VC funds from funding companies that deal in cannabis, gambling and sex (also known as vice companies). Due to these vice clauses, vice startups have historically remained underfunded and overlooked.
So how do vice startups get their funding?
While vice clauses might seem like a blanket ban on anything that the LPs consider problematic, there are still VCs that do see the profitability of investing in vice companies. This is evident in the over US$700 million that has been invested in the cannabis industry as of 2018.
Some investment firms, like Founders Fund, have no vice clauses in place. The firm believes that its LPs invest in it because Founders Fund seeks out entrepreneurial talent irrespective of sector. With a US$75 million investment, Founders Fund has joined in on Privateer Holdings, a company that makes acquisitions and investments in marijuana startups.
Another investment firm that actively invests in vice startups is the aptly named Vice Ventures. The firm’s investment portfolio includes Recess, a beverage brand that infuses CBD (cannabidiol, a byproduct of the Cannabis plant), adaptogens as well as Indose, a precision-focused cannabis vaporizer, into sparkling water.
So why should VCs invest in vice startups?
Catharine Dockery, the founding partner of Vice Ventures, suggests that vice industries have been around for a while and are proven streams of profits and revenues. For her, in spite of the revenues, the widely debated ethical responsibility of VCs proves to be a point of contention when discussing vice companies.
An example of this ethical dilemma is the discussion surrounding the e-cigarette company Juul. On one hand, Juul helps its customers overcome their habit of smoking cigarettes, but on the other hand, evidence suggests that e-cigarettes act as a gateway to traditional smoking among youth.
Dockery addressed the question of investment ethics by stating that VC responsibility is often ignored when discussing the impact of traditional industries, like fossil fuel and alcohol production. She is of the opinion that every investment decision has social consequences and, thus, VCs should support startup founders that have society’s best interests at heart, irrespective of whether it is a vice company or not.
Header image courtesy of Unsplash