Growing a startup is hard business. As is investing in one.
Tens of billions of new investment dollars are up for grabs every year. Competition for those dollars is fierce. And failure is common.
But for those who find success?
It can bestow vast riches on founders and investors alike.
This is not exactly a recipe for white-gloved behavior.
I never believed that Silicon Valley operated on a higher moral plain than Wall Street or any other part of our economy.
So Erin Griffith’s must-read article in Fortune, “The Ugly Unethical Underside of Silicon Valley,” wasn’t a shocker to me.
But I was still taken aback.
Far from being better, could Silicon Valley actually be worse?
Could it really be a breeding ground of dishonesty, greed and rule-breaking?
Griffith implies so.
Take Theranos, for example.
You know, the well-known biotech startup once at the top of the mountain now wrought with lawsuits and conspiracies…
Thinking of Theranos led us to pose some questions.
Question No. 1
Griffith quotes a VC veteran asking this question of Theranos…
“What if Theranos is the canary in the coal mine?”
In other words, what if cheating and lying isn’t the exception? What if it’s the norm?
It’s a serious accusation, something I felt I had to respond to – especially as it relates to the crowdfunding ecosystem.
I’ve made this point before, but it bears repeating.
Venture capital investing and crowdfunding are not the same. They share some things in common, but not everything.
Rather than twins, think cousins.
Similarly, some Silicon Valley companies do crowdfund. But startups from all over the country seek investments from crowdfunders.
Silicon Valley should not be considered crowdfunded startups’ real – or even mythical – home.
Question No. 2
In an article I wrote nine months ago, I asked a different question of Theranos…
“Imagine a thousand eyes focused on Theranos’ technology and business… Would they have noticed the several caution flags flapping in the wind?”
Could “a thousand eyes” have stopped the lying and cheating of Hampton Creek, Lending Club, Zenefits, Skully, ScoreBig, Rothenberg Ventures, Faraday Future and Hyperloop One?
All guilty of breaking the rules, says Griffith.
Should crowdfunders expect anything different from their startups?
The Price of Raising Private Money
Make no mistake, it matters.
If you can’t trust the founders and/or the information they give you, you’re taking on more risk.
This is important.
My gut response? If a founder wants to fool you, they probably can. And no amount of due diligence and document collecting can change that fact.
We like our founders to be brilliant, can-do, ambitious, charismatic and optimistic. You really think they’d have a problem with something as simple as duplicity – exaggerated metrics here or a little stretching of the truth there?
C’mon. We’re basically at their mercy.
But don’t run for the hills quite yet. There are offsetting factors to consider.
For one, the SEC prohibits “bad actors” from crowdfunding. If you’ve been caught breaking the law before, you can’t crowdfund.
But far more important is the psychology involved.
The immense pressures founders face with their venture capitalists largely go away when they crowdfund.
Let me explain…
What venture capitalists demand of their founders above all is growth. And not just growth, but hypergrowth.
Here’s Griffith quoting one founder…
“Every time I meet my investors, they’re asking me, ‘how can we pour more gas on the fire?’”
In an ecosystem where “moving fast” and “breaking things” are encouraged (if not glorified), the pressure to break the rules in order to grow fast can be rationalized as either necessary or – with a slightly smaller dose of self-deception – a necessary evil.
Most founders consider this to be the “price” of raising money in the private sector.
But not all founders.
Crowdfunders’ Different Game
Some choose crowdfunding because they don’t want to deal with the demands of venture capitalists to grow faster and faster.
It’s not that crowdfunders don’t want a large financial return.
But with their small individual stakes, crowdfunders simply aren’t in a position to make threatening demands… as in “double your revenue or you can kiss our $5 million check in your next round goodbye.”
Crowdfunders play a different game.
They help their companies by spreading the word to their friends, facilitating the process of turning customers into investors and investors into customers.
That’s the magic of crowdfunding.
At the dawn of the crowdfunding era, it’s already proven to be an effective model and the preferred model for a growing number of founders.
I expect less pressure to grow at unsustainable rates will translate into fewer acts of rule-breaking.
Crowdfunding Not Completely Off the Hook
Like venture capitalists, we’re still giving very young and inexperienced entrepreneurs gobs of money.
And we still expect to be compensated with outsized returns.
Dave McClure, who heads up 500 Startups, probably encapsulates the thinking of early investors best when he says, “We hope that entrepreneurs bend the rules but don’t break them.”
It’s a fine line not everybody can tow. I’ve personally seen founders not just cross the line, but stomp on it without any apparent sense of wrongdoing.
This is a problem (like many in life) that you can manage but not really solve. Here’s what I do:
- I have several conversations with founders. One is not enough. One of those conversations should be about one thing – themselves, their past trials, successes and failures. Listen to how they frame their own story. Rudyard Kipling’s great quote comes to mind: “If you can meet with Triumph and Disaster and treat those two impostors just the same… Yours is the Earth and everything that’s in it.”
- I give more weight to the 35 and older set than to the 34 and younger one.
- I do my due diligence. (You can have us do this for you.) NO EXCUSES. Investors in Uber’s latest round got a garden variety set of risk factors – and that’s all they got. I heard the same thing about Theranos’ latest rounds.
Listen, I don’t care how “special” you think the opportunity is. Do not skip this last step. It’s not foolproof. But the best way to build a solid foundation of trust with your founders is to learn everything you can about them and their companies.
It’s unreasonable to think that crowdfunded startups will be completely immune to bad behavior.
But at least the vast majority of them aren’t in the pressure-cooker environment that VC-backed companies often find themselves in.
Bad behavior should be far less rampant.
That said, you should remain vigilant. I know I will.
Invest early and well,
Founder, Early Investing