A little late to talk about red flags when it comes to risky investing? • TechCrunch


Earlier today, famed VC Bill Gurley listed many “red flags” that VCs should have paid more attention to when funding FTX, suggesting in a Tweeter that this summary of the warning signs could help keep VCs “out of the hurt investor locker” going forward. Gurley includes non-nos such as “unique financial data presentations”, “aversion to audits”, “significant side transactions” and “lack of a legitimate board of directors”.

However, publishing them now is a bit like shouting “Fire!” after everyone is already outside the theater, watching his smoldering remains dissolve in the parking lot. Most of the behavior Gurley identified today stopped when the market suddenly changed in the spring, and by then the damage was already done. Also, if history has shown us anything, it will happen again and not because VCs miss red flags, but because they sometimes throw those investment rules out the window.

Gurley claims, for example, that one of the reasons the startup market crashed was because investors were “let the good times roll” (red flag #1). It is quite difficult to argue with this one. Consider how well the VCs really knew about Samuel Bankman-Fried, while restoring his image as a crypto industry prodigy. (Weirdly, Sam Bankman-Fried’s smiley face is still stuck in parts of San Francisco.)

Gurley also cites the “absence of legitimate advice” as a red flag (#2). It was another nod to FTX, which didn’t have a board, but barely-there boards became ubiquitous. In an article tonight on Pipe, Mary Ann Azevedo of TechCrunch writes that the three-year market has only one outside board member who is not a co-founder of the company, and that individual is a VC for three years. (Pipe has raised over $300 million from more than a dozen companies.)

Another issue is dual-class (red flag #3) stocks, which in many cases give entrepreneurs the power to ignore investors’ wishes. The VCs once opposed them, but long ago gave in to the founders’ demands, ridiculous as they were. Don’t believe us? Lyft founders and Snap founders have stocks designed to keep them in check until they kick things off. Adam Neumann had so much control over WeWork that had he not been ousted, his children and grandchildren might have been in charge of the company ultimately.

And, Gurley sees secondary sell trades (red flag #8) as an obvious danger. Hopin, the virtual event platform, is a great example. The three-year-old company has struggled with shrinking market share and layoffs, but according to a Financial Times article from earlier this year, its founder was able to withdraw $195m worth of stock of the table while retaining nearly 40% of the company and voting control. Bankman-Fried also took $300 million off the table last fall in a $420 million round when FTX was just two years old.

One problem with Gurley’s indictment against his peers is that Gurley himself was complicit in some of these offenses. Remember WeWork, which promised that Adam Neumann’s offspring would run the company for eternity? Gurley’s business – Benchmark – had a seat on the company’s board of directors.

The biggest problem has to do with how venture capital firms are structured and remunerated. VCs can afford to push it to the limit because they know someone else – their own investors – will be there to pick up the pieces.

Unfortunately, the picture is not so rosy for everyone. Rather, the consequences of every “red flag” that has been waved become more apparent with every layoff, downgrade and change in direction.

The VCs had a good run, and they will do it again. But right now, if you don’t believe that tens, if not hundreds, of billions of dollars from pension funds, school endowments, hospital systems and others that provide capital to VCs are about to go up in smoke, you weren’t paying attention.

It’s not just FTX that’s going down, not by a long shot.



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