News Alert: Survey Suggests VC’s Responsible for Funding Fiasco at FTX
From the Term Sheet newsletter, March 1, 2023:
When money disappears, and criminal fraud charges are filed, there’s a single question that always manages to surface shortly thereafter: Who’s to blame?
There are the founders and CEOs, obviously. Sam Bankman-Fried, who is currently under house arrest at his parent’s home on the Stanford University campus, could be sentenced to up to 115 years in prison. Other founders have faced repercussions for their actions: Elizabeth Holmes of Theranos, who was sentenced to more than 11 years in prison at the end of 2022; Ozy Media’s Carlos Watson, who was arrested at the end of last week for allegedly defrauding investors and identity theft; or former MoviePass chairman Ted Farnsworth, who has been charged with artificially inflating the startup’s parent company stock price, to name a few.
But the finger-pointing doesn’t stop when the court proceedings begin. Who enabled Sam Bankman-Fried to build such a far-reaching and influential cryptocurrency empire? Should venture capital investors like Sequoia Capital, Paradigm, Thoma Bravo, Tiger Global, SoftBank, and the Ontario Teachers’ Pension Plan have spotted major problems in FTX’s financials? Should they have balked at the red flags including FTX’s Excel files that Fortune has reported eschewed traditional management structures, board oversight, teams of accountants and lawyers, and other standard practices of businesses that grow to this size?
A customer lawsuit filed earlier this month against Sequoia, Paradigm, and Thoma Bravo, alleges these funds gave an “air of legitimacy” to FTX and — via their hundreds of millions in funding and public statements that touted Bankman-Fried as a visionary startup founder — propelled the crypto exchange to the success and notoriety it once held.
The FTX debacle was embarrassing enough for Sequoia’s partners including Alfred Lin, who led Sequoia’s investment, to apologize to the firm’s limited partners on a call. And Sequoia took down the glowing profile of Sam Bankman-Fried it has featured on its website. The Ontario Teachers’ Pension Plan has published its FTX losses. (Spokespersons for Sequoia, Tiger Global, Thoma Bravo, and SoftBank declined to comment. Other investors didn’t respond to requests for comment before publication.)
But all of this begs an important question, particularly as venture capital-backed companies have become so large and billion-dollar venture firms now play such an outsized role in the private market ecosystem: When a startup blows up in a big way, when a lot of people lose their money or get hurt, is that just a costly mistake for investors — or do they share some kind of larger responsibility for the harm it causes to everyday people?
In Semaphore’s 15th annual confidence survey — which surveys private equity, venture capital, hedge fund, and other professionals on the state of the private markets — Term Sheet submitted a question to the roster: Is the VC/managed investment community at all responsible for the FTX implosion?
Seventy percent of the 701 dealmakers queried in this year’s survey said yes — investors do share some kind of responsibility.
Here is a sampling of some investors who weighed in on the matter, anonymously:
Part of the 70% that believes they are responsible:
A little, they are lemmings. They follow a named investor who hasn’t done diligence and call that checking the box. No adults in the room.
Total absence of responsible diligence, no requirement for basic corporate governance and then no follow-up. Shameful.
Cult of the founder, founder-worship, fetishizing non-conformity
VC’s need to be more firm and reject founders who have these character traits. The era of the celebrity founder is over and discipline is back.
Complicit as hell.
And from the vc apologists:
Obviously we fund these people, but there’s a lot of amateur investors playing in the space. Diligence becomes harder and harder when you need to move quickly to get into rounds. The founder bears most of the responsibility for defrauding innocent people, but it’s inherent in our jobs to bet on ridiculous ideas. It’s not the first time and won’t be the last, but if we take longer to do our diligence we lose out on the investment opportunity — it’s a problem that will not be solved overnight and something venture folks don’t lose sleep over. We do lose sleep over the port cos that are obviously affected by the fallout so it’s not without its repercussions.
Are they responsible? Partly, but not solely. They should have done diligence. However, they cannot front the blame for someone’s egregious actions. And herd mentality is real in the VC community. Fast term sheets became way too “in style” and too little diligence was done across that industry as a whole. I blame them for that part for sure. But it’s also not their responsibility to be dialed in to the day to day of FTX. But they certainly should have been more involved than they were.
