Spotting & Stopping the Slippery Slope of Ethical Lapses at Startups
I’ve had the good fortune to be an investor for almost 15 years and have backed 100s of startups. Only one company in all that time deliberately defrauded its VCs. Catastrophes like Theranos (not an investor) are shocking in part because outright fraud is mercifully rare.
However, one benefit of the startup ecosystem — that there are many paths to success and the field of acceptable practices is wider than most kinds of business — is also a weakness. The line between “rule” and “best practice” sometimes blurs under stressful conditions.
It’s all too easy, with the best intentions, to start down a slippery slope. For example, an entrepreneur might off-handedly mention that they’ve “signed” a certain key customer when in reality, they only have a MoU.
Or, installation fees are accidentally blended with recurring revenue in a pitch deck. Neither is an outright lie, or completely unethical, but it’s the start of … uncomfortably close.
This isn’t just an issue among founders. The expectations of the industry are absurdly high. Companies are encouraged to burn to grow unsustainably fast, and if they can’t, they risk being cut off. Clearly creating bad incentives.
High standards don’t absolve either party of wrongdoing, but they help explain quite a bit. And VCs can do more to suss out, and act on, unethical behavior before it develops into something worse.
When investors see:
🐌 Emails that merit 30 seconds replies languishing for weeks…
🕵️♂️ Financial statements that come in late or are oddly abridged…
🙈 Questions that are answered evasively…
They should act. There are many small tells, and these are the easy ones.
The scariest danger signs sometimes simply look like unnaturally positive developments. Maybe revenue appears to accelerate rapidly, without rationale (sometimes just before a fundraise). Has product/market fit unlocked? Neither founders nor investors should risk a markup…
Lapses in ethics often happen when a founder makes a mistake, usually innocently enough, and then it snowballs. If an attentive investor noticed the irregularity early, they may be able to stop it before it kills the company.
Sometimes, this will mean having to write-down, or off, a promising startup. Embarrassing as it may be, it’s better than the alternative.
My advice to entrepreneurs: If you find yourself in the ethical quicksand, call for help ASAP. You may believe that landing a key deal or a knockout quarter will turn your fortunes around, but it probably won’t. Be a whistleblower in your own startup.
I won’t lie here to you. It’s going to be painful. If you’ve misled your investors, don’t expect them to be happy. Depending on the severity of the ethical lapse, you may even be asked to leave. As painful as that is, it’s not the end of the world.
You can come back from a failed startup. The org charts of tech companies are filled with people who burned hundreds of millions of investor dollars on doomed startups. But losing your good name, your reputation, is irretrievable.
Managing Partner David Frankel recently shared this as a tweetstorm. We collected the tweets as a post for your convenience. Please share it with any entrepreneurs you know who are struggling with tough choices.