The end of Silicon Valley pretense

SAN FRANCISCO — The pretense is over. This is what Silicon Valley feels like, with some schadenfreude and a touch of paranoia.

Not only has funding for cash-burning startups dried up over the past year, but fraud is now ramping up as investors scrutinize startups’ claims more closely, and the tech downturn has revealed who has been taking the industry’s “fakes” The “until you make it” ethos goes too far.

Take what happened in the past two weeks: Charlie Javice, the founder of financial aid startup Frank, was arrested on charges of falsifying customer data. Jury finds Rishi Shah, co-founder of adware startup Outcome Health, guilty deceiving customers and investors.There is still one judge ordered Elizabeth Holmes, the founder of defrauding investors in her blood-testing startup Theranos, is to be sentenced to 11 years in prison starting April 27.

These developments follow the February arrest of Ozy Media founder Carlos Watson and the Christopher Kirchner, the founder of software company Slync, has both been charged with defrauding investors.upcoming is Fraud The trial of Manish Lachwani, the co-founder of software startup HeadSpin, will begin in May, and Sam Bankman-Fried, the founder of cryptocurrency exchange FTX, will face 13 fraud charges later this year.

All in all, the chorus of charges, convictions, and sentences makes it feel like the fast-and-loose fakery of the startup world actually has consequences. Despite this generation’s many high-profile scandals (Uber, WeWork) and downfalls (Juicero), few startup founders other than Ms. Holmes have been credited with disrupting the future of our business while disrupting our future. face criminal charges.

Slumping funding may be to blame. Immoral behavior In good times, they can largely go unnoticed, like tech startups in the 2010s. Funding for U.S. tech startups rose eightfold between 2012 and 2021, to $344 billion, according to PitchBook, which tracks startups. Of these, more than 1,200 are considered “unicorns” with a paper value of $1 billion or more.

But when the easy money dries up, everyone is copying Warren Buffett’s adage of finding out who’s swimming naked when the tide goes out. After FTX filed for Chapter 11 bankruptcy last November, Airbnb CEO Brian Chesky renew A motto for millennial tech founders: “It feels like we’re in a nightclub and the lights just went on,” he tweeted.

In the past, venture capital investors backing start-ups were reluctant to take legal action when they were scammed. These companies are small, with little assets to recover, and chasing founders can damage investors’ reputations. This has happened as unicorns have soared, attracting billions of dollars in funding, and larger, more traditional investors, including hedge funds, corporate investors and mutual funds, have entered the investing game changed.

“There’s more money involved, so it just changes the calculations,” said Alexander Dyck, a finance professor at the University of Toronto who specializes in corporate governance.

The Justice Department has also been urging prosecutors to “be bold” to go after more business fraud, including in private start-ups. Hence the charges to the founders of Frank, Ozy Media, Slync and HeadSpin and more to come.

IRL, a messaging app valued by investors at $1 billion, is under investigation by the SEC for allegedly misleading investors about how many users it had, According to The Information. Rumby, an Ohio laundry startup, allegedly Fabricated A story of a financially successful funding that its founders used to buy themselves a $1.7 million houseaccording to a lawsuit by one of its investors.

News outlets also report unethical behavior by startups including olivesa $4 billion healthcare software startup, and Nate, a E-commerce business Claims to use artificial intelligence. A spokeswoman for Olive said the company “disputes and denies” the reported allegations.

All of this creates an awkward moment for venture capital investors. When startup valuations soar, they are seen as visionary kingmakers. It’s easy to convince the world and the investors in their funds — pension funds, college endowments, and the wealthy — that they are responsible stewards of capital with what it takes to predict the future and find the next Steve Jobs to build it unique skills.

But as more and more start-up frauds are revealed, these industry giants are playing a different role in lawsuits, bankruptcy filings and court testimony: victims of deception.

Alfred Lin, an investor at Sequoia Capital, a top Silicon Valley firm that invested $150 million in FTX, once Launch Events in January“It’s not that we made an investment, it’s a year and a half of working relationship that I still haven’t seen,” he said. “That’s hard.”

Venture capital investors say their asset class is one of the riskiest places to park their money, but with the potential for big returns. The startup world celebrates failure, and if you don’t fail, you’re seen as not taking enough risks. But it’s unclear whether that defense will stand as the scandal grows more humiliating for all involved.

Eden Abrahams, a partner at the firm, said investors were increasingly asking advisers like RHR International to help identify the signs of “manipulative narcissists” who were more likely to commit fraud. “They want to strengthen the protocol around how they evaluate founders,” Ms Abraham said. “We’ve had a series of events that should cause people to reflect.”

Start-ups have many of the conditions most associated with fraud, Mr Dyke said. They tend to employ novel business models, their founders often have significant control, and their backers don’t always exercise strict oversight. That’s ripe for a game changer when a downturn hits. “It’s not surprising that we’ve seen a lot of the fraud that happened over the past 18 months now come to light,” he said.

When Ms. Javice was trying to sell her college financial planning startup, Frank, to JPMorgan Chase, she allegedly told an employee not to reveal the exact number of people using Frank’s services. SEC ComplaintShe later asked the employee to fabricate thousands of accounts, assuring her employees that such moves were legal and that no one would end up in an “orange jumpsuit,” the complaint said.

After JPMorgan buys the startup for $175 million in 2021, Frank’s investors Fast Celebrate the win on Twitter. “More students and families will now have greater access to financial aid and #highered opportunities,” said an investor at Reach Capital wrote“It’s great to know that you will now have an even bigger platform to positively impact the lives of so many people!” Yes commend An executive from Chegg, which invested.

Ms Jarvis faces four counts of fraud.Last week, JP Morgan defendant She transferred the money to a shell company after the bank discovered she was involved in fraud.

Outcome Health, which sells drug ads on screens in doctors’ offices, has raised $488 million from investors including Goldman Sachs, Google-affiliated fund CapitalG and the family of Illinois Gov. JB Pritzker, while publicly touting high growth and profitability. In fact, the company is missing its revenue targets, is struggling to manage its debt load and overcharging customers.

Investors poured in money anyway, even allowing Outcome Health co-founders Shah and Shradha Agarwal to cash out $225 million worth of stock. Todd Cozzens of Leerink Partners, one of the company’s smaller investors, said he wasn’t deterred by missed revenue targets and other “sloppy” red flags because “they could have fixed that.” He said the company committed fraud when it changed sales reports in a way that would be difficult for outsiders to detect.

“It’s a great business model and the product works, but the founders were really greedy,” he said. “They want more.” Mr Cozzens’ company lost 90 percent of its $15 million investment.

mr shah is conviction 19 counts of fraud and Ms Agarwal 15 counts of fraud. A spokesman for Mr Shah said he was “deeply saddened” by the verdict and planned to appeal. Ms Agarwal’s lawyers said they were reviewing the sentence and considering her options.

Slync’s founder, Mr. Kirchner, lied to investors about Slync’s operating performance and used the funds raised to purchase a $16 million private jet for himself, among other misappropriation, According to the SEC complaint. The complaint alleges that when an investor gained insight into Slync’s financial situation, Mr. Kirchner told the person that Slync was moving to a new financial services provider. Investors wired $35 million.

A spokesman for Slync said the company had appointed a new chief executive and was cooperating with the government’s investigation. And “looks forward to a fair resolution of this matter.”

FTX has raised nearly $2 billion from top investors including Sequoia Capital, Lightspeed Venture Partners and Thoma Bravo, bringing its valuation to $32 billion.According to an employee, the company is so poorly run that it doesn’t even have a full list of employees Report The company’s new management was announced this month. Mr. Bankman-Fried once told colleagues that FTX’s sister hedge fund, Alameda Research, was “unauditable,” and that the team sometimes found $50 million in assets lying around, but they had lost track. “This is life,” he wrote.

Sequoia commissioned Mr. Bankman-Fried to post a glowing image on its website and apologize to investors after the firm collapsed. It also removes configuration files.

Mr. Lin explained at the entrepreneurial event that the venture capital industry is ultimately an industry based on trust. “Because if you don’t trust the founders you work with,” he said, “why would you invest in them?”