SAN FRANCISCO – Faking it is over. That’s the feeling in Silicon Valley, along with some schadenfreude and a pinch of paranoia.
Not only has funding dried up for cash-burning start-ups over the past year, but now, fraud is also in the air, as investors scrutinise start-up claims more closely and a tech downturn reveals who has been taking the industry’s “fake it till you make it” ethos too far.
Take what happened in the past two weeks: Charlie Javice, the founder of the financial aid start-up Frank, was arrested, accused of falsifying customer data. A jury found Rishi Shah, a co-founder of the advertising software start-up Outcome Health, guilty of defrauding customers and investors. And a judge ordered Elizabeth Holmes, the founder who defrauded investors at her blood testing start-up Theranos, to begin an 11-year prison sentence on April 27.
Those developments follow the February arrests of Carlos Watson, the founder of Ozy Media, and Christopher Kirchner, the founder of software company Slync, both accused of defrauding investors. Still to come is the fraud trial of Manish Lachwani, a co-founder of the software start-up HeadSpin, set to begin in May, and that of Sam Bankman-Fried, the founder of the cryptocurrency exchange FTX, who faces 13 fraud charges later in 2023.
When the money dries up
Taken together, the chorus of charges, convictions and sentences have created a feeling that the start-up world’s fast and loose fakery actually has consequences.
Despite this generation’s many high-profile scandals (Uber, WeWork) and downfalls (Juicero), few start-up founders, aside from Holmes, ever faced criminal charges for pushing the boundaries of business puffery as they disrupted us into the future.
The funding downturn may be to blame. Unethical behaviour can largely be overlooked when times are good, as they were for tech start-ups in the 2010s.
Between 2012 and 2021, funding to tech start-ups in the United States jumped eightfold to US$344 billion (S$458 billion), according to PitchBook, which tracks start-ups. More than 1,200 of them are considered “unicorns” worth US$1 billion or more on paper.
But when the easy money dries up, everyone parrots the Warren Buffett proverb about finding out who is swimming naked when the tide goes out.
After FTX filed for bankruptcy in November, Mr Brian Chesky, CEO of Airbnb, updated the adage for millennial tech founders: “It feels like we were in a nightclub and the lights just turned on,” he tweeted.
In the past, the venture capital investors who backed start-ups were reluctant to pursue legal action when they were duped. The companies were small, with few assets to recover, and going after a founder would hurt the investors’ reputations.
More money at stake
That has changed as the unicorns have soared, attracting billions in funding, and as larger, more traditional investors including hedge funds, corporate investors and mutual funds have entered the investing game.
“There is more money at stake, so it just changes the calculus,” said Mr Alexander Dyck, a professor of finance at the University of Toronto who specialises in corporate governance.
The Justice Department has also been urging prosecutors to “be bold” in its pursuit of more business frauds, including at private start-ups. Thus, charges for founders of Frank, Ozy Media, Slync and HeadSpin and expectations of more to come.