Outrageous fraud is common in the world of venture capital
With so much media focus on Elizabeth Holmes — currently on trial for fraud — you might think that cases like these, of outright fraudsters raising huge money from gullible venture capitalists, are few and far between. But as a VC myself I can tell you: most venture funds have their own Theranos story — they just prefer to keep them quiet.
VCs are always looking for “visionary” founders, but the line between visionary and conman is wafer thin. They often have to make big investment decisions within a few days (the original Google investment was made over a weekend), which means that the scope for fraud is immense. When it does happen, it’s often better to write it off quietly than sue and face embarrassing headlines. After all VCs expect 40% of investments to go to zero.
A few make the news. Erlend Olson, a charismatic cowboy-hat-wearing former NASA scientist, persuaded Kleiner Perkins, Goldman Sachs and others to invest $300M in “Terralliance”, which promised to use “big data” from aeroplanes and satellites to find oil fields. It’s still unclear whether the tech ever worked, but somehow $20M ended up in Olson-related offshore trusts, one of which, I kid you not, was called The Pink Panther.
Mozido was a much talked about mobile payments company, raising hundreds of millions at a $4B valuation from investors including Tiger. But it turned out the founder, Michael Liberty, was siphoning tens of millions into private jets, a dairy farm and a movie produced by his girlfriend. He’s a rare one who got caught — until he was pardoned by Donald J. Trump.
Another common kind of fraud is when founders “fake it until they make it” — showing investors embellished numbers “up and to the right” before attempting to make them up in the next quarter. Some call it “pre-telling the truth”.
Recently, the SEC caught Headspin faking their numbers. Headspin had persuaded top VCs like GV (Google Ventures), Battery & ICONIQ that they were “one of the fastest-scaling software companies ever” — sadly by inventing clients and fudging figures.
Even more commonplace deception in the VC world is “buying” revenue. When companies are valued at up to 20 times their annual revenue, every dollar of revenue adds twenty dollars to the valuation, so it’s tempting to offer kickbacks and other ruses to flatter the numbers (“I’ll pay you to buy my software”). This was the accusation levelled at Mike Lynch of Autonomy, and several healthcare software companies have been caught out (Singulex, Cloudcare, etc.).
Then there are the companies that burn such vast quantities of cash it might as well be fraud. Boo.com, Webvan and eToys burned multi-millions per month in the dot-com boom. Yet they’re dwarfed by more recent cash bonfires like Katerra ($1.5 billion), Magic Leap ($3 billion and counting), Oyo ($4 billion) and, of course, WeWork (which could be as much as $20 billion).
But perhaps most embarrassing of all is the fraud that is perpetuated inside a venture fund. “Shifty” Ifty Ahmed, then a partner at Oak Capital, had a clever tactic: when making a multi-million-dollar investment, he would arrange to “invest” an extra few million in the recipient company; then phone the company, apologise for the embarrassing error and ask them to “return” the difference — to his own account. Apparently he swindled $65M this way before anyone noticed. Oak Capital managed nearly $10 billion.
Fraud follows the money, and there’s never been so much VC money, or so many investors falling over themselves to be faster and more “founder friendly” than each other. To quote a fellow VC, when the tide goes out this time around its going to reveal “a naked orgy of fraud”. But until then, VCs will keep toasting the up-rounds and comforting themselves that, even if they have been duped here and there, at least nobody really noticed.
The Secret VC is a partner at a major VC fund and tweets at @TheSecretVC