I’ve been writing about venture capital here for some time. While I recognize it’s an important driver of innovation, I often wonder if it truly serves the purpose of many entrepreneurs and other business operators in creating companies that work for them.

The problem is, companies backed by VCs are no longer dedicated to the best interests of business creators. So what are the basic rules of the game when dealing with these slick intermediaries between private investors and startup hopefuls?

Paul Graham has written an excellent post on this rather arcane subject. #

If a venture capitalist offers you a certain sum of money in exchange for a shareholding in your startup, what are the rules governing these deals and how much of your business should you part with?

According to Graham’s analysis, the answer is : 1/(1 - n)

Whenever you’re trading stock in your company for anything … the test for whether to do it is the same. You should give up n percent of your company if what you trade it for improves your average outcome enough that the (100 - n) percent you have left is worth more than the whole company was before. For example, if an investor wants to buy half your company, how much does that investment have to improve your average outcome for you to break even? Obviously it has to double: if you trade half your company for something that more than doubles the company’s average outcome, you’re net ahead. You have half as big a share of something worth more than twice as much.

If you were in this scenario, you would already have jumped through a lot of hoops to get there. You should bear in mind from the outset that a VC company like Sequoia, for instance, gets about 6000 business plans a year and funds around 20 of them.

Face it, you’re going to have to be good to get the cash, so you are entitled to drive a hard bargain. According to Graham, Sequoia will allow you to do so.

There are many other options available. Whether VC funding is for you is just a little simpler to answer after reading Graham’s interesting piece.