Venture firms are looking for new ways to make money--and elbowing onto investment bankers' turf.

Not content with double-digit rates of return on their investments, some venture capitalists are looking for new ways to milk their portfolio companies—by buying more stock in them when they go public. VCs traditionally have regarded public offerings as an exit strategy, not an investment opportunity. But in the crazy world of technology finance, stock offered to the public can double or triple on the first day. When an offering is likely to be a hot one, VCs want to be buying, not selling. At the time they decide to fund a company, they can negotiate the option to buy newly issued shares at the public offering.

Some underwriters aren't very happy about VCs muscling in on their turf. Ordinarily, investment bankers control who gets most of a new issue, and naturally they dish it out to the largest institutional and retail customers who throw them the most commission business the rest of the year. Other folks—including venture capitalists—could pretty much forget about getting any stock at the offering price. "It was the one meaningful financing event that they didn't have access to," says William Brady of Credit Suisse First Boston.

When an underwriter underprices a hot Internet offering, it is, in effect, creating a slush fund for its favored customers. The underwriting client may not object—it may be thrilled to see its stock bounce up the first day—but it's still leaving money on the table. The VCs are trying to grab some.

The VC option started to appear in later-stage venture deals about four years ago. An early pioneer was Technology Crossover Ventures, which frequently invested in portfolio companies after they went public. "Back then we had to stand in line with everyone else," says partner Jay Hoag. TCV has written the term into more than 30deals, including Autoweb.com, the on-line car dealer, in which $3 million worth of initial offering stock was set aside.

Accel Partners began inserting the provision in early-stage rounds for portfolio companies like Mpath Interactive, which makes software to build communities (say, of karaoke fans) on Web sites. "We view the public offering as just one more step in building the company, and by no means a final one," says Accel managing partner James Breyer.

Downside? Once VCs win the option, it's tricky not to exercise it—people will want to know why the smart money isn't buying stock at the offering, says Bob C. Kagle of Benchmark Capital. Benchmark has asked for the option, sparingly.

Underwriters argue that a young company would do better to set aside shares for a new strategic partner—instead of handing out a bonus to investors who have already made a bundle. But it's hard to say who's being greedier in this game.

Source: Luisa Kroll , Forbes