Venture Capital, What Failure?

The dark alleys of the startup space

The constant pressure for venture capitalists to get ahead of the curve in a highly competitive startup market could be both rewarding or perilous in all cases, it is a double-edged sword of uncertainty. The fear of missing out on an investment that could be a massive success in the near future drives investors into tricky situations that consequently result in utter failure.

“Theranos Inc., a consumer healthcare technology startup, was once valued at $10 billion, and its leadership claimed it would revolutionize the blood-testing industry. However, the technological breakthrough that CEO Elizabeth Holmes and former company president Ramesh Balwani touted was never demonstrated, and the assertions of Holmes and Balwani amounted to outright deceit. Holmes and Balwani were ultimately charged by the SEC for massive fraud. The two executives agreed to settle subject to court approval.” -Investopedia

Theranos inc. was a success story up until it was exposed as a fraudulent scheme that pulled a fast one on investors, the scheme was so elaborate that the best of investors including Rupert Murdoch, a hawkish well-known shark in the startup space, couldn’t pick up on the act and fell knee-deep into the pit of deception. This goes to show that even the most high profile investors get duped.

Financial fraud is a real cause for concern in the world of the venture capitalist, for every opportunity that surfaces might be as risky to the investor. Identifying a bad investment in a fast-paced environment is difficult enough for the investor. We must separate failure from fraud and know how to pick up the telltale signs of dubious activity, the former could be as a result of bad management while the latter is just outright deliberate deception.

Below are some signs to look out for in detecting fraudulent activity:

FOMO (Fear of missing out) — The venture capitalists space is replete with stories of startups that scaled to become industry leaders. Oftentimes, threats fly across the board of organizations about the possibility of losing a golden opportunity that competitors may get a grip of.

For instance, in 1998, Larry Page and Sergei Brin offered to sell their startup to Yahoo for $1 million. Yahoo as at the time was the leading online platform and they declined the offer. The startup was soon to be known as Google which is now much more valuable and profitable than Yahoo today. Such stories have driven the fear of missing out to greater heights which makes venture capitalists jump in headfirst and try to scoop up startups before anyone else does, as a result of this the risk of such ventures ending in misery is significant.

Dubious startups might adopt a means to infuse these fears in potential investors that they may lose out and their competitors will gain, making them to rush into decisions that are questionable.

Stonewalling on due diligence — Not being clear on details such as legal documents, financial statements, research and development and other such significant information that may be of relevance. Investors may be carried away by wonderful ideas and may pay less attention to perform their due diligence. There are standard checklists that must be followed to ensure the genuity of the investment, these include;

• Historical financial information.
• Business model/financial projections.
• Employees.
• Intellectual property.
• Litigation.
• Technology.
• General legal, corporate, and compliance matters.
• Contractual Agreements.

To reduce the risk of the unknown, the list above must be strictly adhered to diligently.

Too good to be true — If it’s too good to be true then it probably is, as there are many indications that points towards this type of activity

“Entrepreneurial fraudsters’ primary playbook is to sell a fantasy instead of a business opportunity. The fantasy could be sinful gratification, like money, sex, or fame; or it could be a positive ideal, like changing the world or backing a visionary, next-generation business leader. Theranos appealed to virtuous desires with its goal of providing a painless and anxiety-free way to collect blood for medical tests. Fyre Festival, on the other hand, promoted a fantasy of cavorting with models on the beach. If hanging out with models isn’t already part of your regular routine, the story you are hearing might be a fantasy and not a legitimate investment.” -Risky Business on Medium

Charisma is a fraudster’s greatest weapon and backing it up with a fantastical tale to rope in an investor is dynamite. Investors must look beyond eloquent speakers, broad shoulders and strong perfumes by looking through a critical glass of reason. By this, you can be on a good date with destiny.

Restricted access to team members — to ask questions related to the business. If you find yourself being put on a leash and refused access to other members of the startup team that could answer questions relating to their duties within the organization then there’s something up about it. Theranos was quite strict with how it allowed its staff to interact with reporters and other stakeholders that had interest in their dealings for the fear of letting out information that could allow the con blow up in their faces.

The aforementioned characteristics may be seen in legitimate startups that have genuinely good intentions but it becomes somewhat suspicious when two or more characteristics are present under one business.

It’s quite risky delving into unknown territory therefore as a venture capitalist caution must be applied to deal with issues relating to fraud by looking at the telltale signs of suspicious activity in its totality.