Why Is IP Infringement Acceptable If You’re A VC?

Every time I write about Chinese Net companies and their recent efforts to crack down on intellectual property infringement, I inevitably get emails and comments that say “Yeah, they’re cleaning up their act now, but they built up their companies/traffic by granting access to illegal MP3s/videos/books.”

The question is, in other words, where’s the justice for so many years of bad acts?

My usual answer is that at some point, you have to let these things go. Sure, we can dwell on all that past IP infringement, but since there is no realistic way of forcing these sites to cough up damages for all that infringement, what’s the point is complaining about it?

But I saw something today that made me think of a related issue. Think back on China’s big portals, video file sharing sites, social media giants, online commerce sites, etc. Quite a few of them received venture capital (VC) funding, foreign and/or domestic, at one point or another.

And when these sites were roundly accused of ripping off IP owners, where was the criticism of the VCs? Yes, I’m sure someone out there at some point was shouting about it, but it didn’t seem to change any industry habits, did it?

Why is it that investors get a free pass?

Here’s some food for thought from the Signature9 blog:

Exhibit A of why Silicon Valley needs more women in the venture capital arena – at the very least during due diligence: Chinese online retailer Milanoo recently sent out a press release {via Tech Crunch} announcing a multi-million dollar investment from the Chinese arm of Sequoia Capital, one of Silicon Valley’s largest and most well established venture capital investment firms.

[ . . . ]

The problem? A sizable portion of the merchandise on Milanoo is comprised of designer replica items and out and out ripoffs of everything from Christian Louboutin and Manolo Blahnik shoes to Cate Blanchett’s lavender Givenchy Golden Globes dress and Kate Middleton’s blue Issa engagement dress.

The fashion industry is way out of my comfort zone, so let’s assume for the moment that all that information is true and that Sequoia has invested in a company that is a known infringer.

Let’s further assume that Sequoia is aware of this activity. I see that the blogger who wrote about this is being nice, starting off the post suggesting that perhaps the VC needs more help with due diligence.

I’m not buying that for a second. I worked at a law firm that did projects for Sequoia, and I can confirm that due diligence is part of the standard process. Moreover, if there was large-scale IP infringement going on, that’s something that would be mentioned in a DD report, unless the law firm in question is totally incompetent.

So I’m going to assume that all this is known to the VC. And yet they went ahead with the investment anyway. Why? Because the IP infringement is simply another business risk. The VC thought about the chances of the site getting in trouble, when the company plans to cease the infringing activity (if it even has plans to do so), and the timeline of the VC’s anticipated exit strategy (public listing or buyout). In the end, the VC thought the risk was worth it.1

I’m sure that the standard excuse is that the VC, or perhaps an angel investor, comes into these deals with plans to help the Net firm clean up its act. Or to put it another way “We’re not profiting on IP infringement, we’re getting on board with the express purpose of ending the IP infringement.” Maybe on occasion, particularly with late stage funding prior to a listing, but there are a whole lot of other VCs out there that are happily making lots of money off of IP infringement.

Just a question then: why are these guys allowed to do this sort of thing repeatedly with no negative consequences? They are enabling large-scale IP infringement, and even if the target company at some point gets into trouble, the VC never faces any direct negative repercussions from all this. Worst thing that happens is that their investment loses value.

Is this a problem or is everyone OK with this?