A list of red flags that VCs should have paid closer attention to when funding FTX was put together by renowned VC Bill Gurley. There are no-nos such as aversion to audits, large secondary transactions, and lack of a legitimate board.
It's like shouting "fire!" after everyone is outside the theater when it's on fire. The damage was already done by the time the market shifted in the spring. It will happen again and not because VCs miss red flags but because they sometimes throw these investing rules out the window.
One of the reasons the startup market cratered was investors letting the good times roll, according to Gurley. It is difficult to argue with this one. Samuel Bankman-Fried burnished his image as a wunderkind despite little knowledge of him from the investment community. Sam Bankman- Fried's smiling visage is plastered around parts of San Francisco.
The lack of a legitimate board is one of the red flags. FTX had no board of directors but barely- there boards have become pervasive. The three-year-old marketplace has only one outside board member who is not a founder, and that individual has been a VC for three years, according to Mary Ann Azevedo. More than a dozen firms helped raise more than $300 million.
Entrepreneurs have the power to ignore investors' wishes with dual-class shares. Even though VCs once argued against them, they still gave into founder demands. Don't think we're right? The shares were designed to keep them in control until they kicked the bucket. Had Adam Neumann not been elbowed out, his children and grandchildren could have taken over the company.
Secondary sale transactions are an obvious danger. A prime example is Hopin. The three-year-old company has been dealing with shrinking market share and layoffs, yet according to a Financial Times piece from earlier this year, its founder was able to take $195 million worth of shares off the table.
$300 million was taken off the table last fall. FTX was less than two years old.
The problem with the indictment of his peers is that he himself was involved in some of the offenses. WeWork promised that Adam Neumann would rule the company for the rest of his life. A seat on the company's board was held by Benchmark.
The larger issue is how venture firms are structured. It's possible for VCs to push it to the limit because they know their own investors will be able to pick up the pieces.
The picture isn't as good for everyone else. Each layoff, down round, and executive change-up is showing the consequences of every red flag that was waved away.
There was a good run by VCs. If you don't know that tens of billions of dollars from pension funds, school endowments, hospital systems, and others are going to go up in smoke, you haven't been paying attention.
FTX is not the only one going down.
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