5 ms·

Should I be amazed at the lack of due diligence from investing firms, not just in this case, but generally? Or, maybe I shouldn’t be surprised, after all, this

by Amygaz 7y ago

Should I be amazed at the lack of due diligence from investing firms, not just in this case, but generally? Or, maybe I shouldn’t be surprised, after all, this isn’t their money. If it sounds good it probably is. They only need to be right 10% of the time...

hylaride 7y ago
At a startup I worked for, the founder once told me how surprisingly little due diligence was done for their series A. They showed the investors the product, explained the industry and their goals, signed some papers, and a week after the ink dried there was a wire for a few mil. I'm sure VC firms price in the risk of a few of their investments being incompetent/fraudulent (they can probably be written off as losses, too), but it's still one of those 'huh' moments. That being said, the scale of Quintillion, Theranos, etc should have had some more proper due diligence. Circular contracts should be a well understood red flag after Enron, etc.
- arethuza 7y ago
  The only time I've been directly involved in that kind of scenario (as a co-founder during the first .com bubble) - there was some due diligence for the first round - but looking back it was almost comically superficial. Afterwards at subsequent rounds the amount of money grew stupendously but the due diligence disappeared completely - presumably because each of the myriad of investors assumed that somebody else was checking things.
  - jandrese 7y ago
    Due diligence is like work. If these VCs are only putting a million bucks into something it probably doesn't even make sense to do more than a cursory look over of the company. Their time is too valuable to waste on that. Most of these investments are already assumed to be a total loss, they only do them because when they do land on a hit the returns can be astronomical.
    - ben_jones 7y ago
      If only there was some method of exchanging money for the time of professionals capable of vetting a technical product and giving a summarized report.
      - btown 7y ago
        VCs don't even have the time to source and coordinate professionals for vetting. They're weighing what they view as a million-to-one chance (because a VC principal thinks highly of their ability to detect a shady person) of a million-dollar loss due to fraud, and the >3 hours of time required to find a professional, get them under NDA, schedule them with the portfolio company... is worth far less to them.
        ben_jones 7y ago
        I disagree, here [1] is a small clip from a really powerful documentary on the subject of Venture Capital and finance. [1]: https://www.youtube.com/watch?v=xbBD7VIJ4cc https://www.youtube.com/watch?v=xbBD7VIJ4cc
        vidarh 7y ago
        I work for a VC, and it's sort-of like this. Not so much because we think so highly of our ability to detect shady people, as because the checks we do are fine most of the time, and constantly being refined. But they do need to be cheap - it's not easy to place money and manage that portfolio for 5-10 years cheap enough to actually make a good return when factoring in investments that fail for reasons that are far harder to identify ahead of time than outright fraud. The outright frauds are rare enough that checking for them needs to be very cheap for it not to be more cost-effective to spend that money improving other deal-flow filtering. That's not to say that VCs aren't trying to improve on it. It's just that fraud is just one of many risks, and managing risk is about taking a dispassionate view of which measures improve your returns the most.
        catalogia 7y ago
        I think we should consider whether there might be a social responsibility to not fund scammers. Rather than considering the matter purely from the perspective of the investor's bank account, we should consider the broader impact of allowing scammers to find investors. It degrades the reputation of the industry every time it happens, and frankly I think it degrades society. Every time a scammer is enriched, society as a whole is harmed.
  - cr0sh 7y ago
    > presumably because each of the myriad of investors assumed that somebody else was checking things Would that be something akin to the "bystander effect"?
KoftaBob 7y ago
I'm becoming increasingly convinced that because of the "spray and pray" approach of the VC model in which a small % of their investments make up the bulk of their returns, the most successful VC firms are largely the ones with the most money to spray, not due to some visionary abilities they have.
- ASalazarMX 7y ago
  This would explain why they hunger for explosive growth, to make up for the majority of their investments.
  - WalterSear 7y ago
    It's exactly where the hunger comes from.
- the_watcher 7y ago
  Wouldn't this suggest Softbank as the most successful VC?
HALtheWise 7y ago
I wonder whether fraudulent startups would actually fail due-diligence checks reliably. If it is well known that investors look for certain things, Elizabeth Holmes would probably find a way to pass those checks, but well-intentioned founders might not put as much effort into compliance. From what I've seen of "compliance" paperwork in other industries, it sometimes just adds a ton of paperwork without actually preventing much fraud.

by Amygaz 7y ago

hylaride 7y ago

At a startup I worked for, the founder once told me how surprisingly little due diligence was done for their series A. They showed the investors the product, explained the industry and their goals, signed some papers, and a week after the ink dried there was a wire for a few mil. I'm sure VC firms price in the risk of a few of their investments being incompetent/fraudulent (they can probably be written off as losses, too), but it's still one of those 'huh' moments. That being said, the scale of Quintillion, Theranos, etc should have had some more proper due diligence. Circular contracts should be a well understood red flag after Enron, etc.

arethuza 7y ago
The only time I've been directly involved in that kind of scenario (as a co-founder during the first .com bubble) - there was some due diligence for the first round - but looking back it was almost comically superficial. Afterwards at subsequent rounds the amount of money grew stupendously but the due diligence disappeared completely - presumably because each of the myriad of investors assumed that somebody else was checking things.
- jandrese 7y ago
  Due diligence is like work. If these VCs are only putting a million bucks into something it probably doesn't even make sense to do more than a cursory look over of the company. Their time is too valuable to waste on that. Most of these investments are already assumed to be a total loss, they only do them because when they do land on a hit the returns can be astronomical.
  - ben_jones 7y ago
    If only there was some method of exchanging money for the time of professionals capable of vetting a technical product and giving a summarized report.
    - btown 7y ago
      VCs don't even have the time to source and coordinate professionals for vetting. They're weighing what they view as a million-to-one chance (because a VC principal thinks highly of their ability to detect a shady person) of a million-dollar loss due to fraud, and the >3 hours of time required to find a professional, get them under NDA, schedule them with the portfolio company... is worth far less to them.
      - ben_jones 7y ago
        I disagree, here [1] is a small clip from a really powerful documentary on the subject of Venture Capital and finance. [1]: https://www.youtube.com/watch?v=xbBD7VIJ4cc https://www.youtube.com/watch?v=xbBD7VIJ4cc
      - vidarh 7y ago
        I work for a VC, and it's sort-of like this. Not so much because we think so highly of our ability to detect shady people, as because the checks we do are fine most of the time, and constantly being refined. But they do need to be cheap - it's not easy to place money and manage that portfolio for 5-10 years cheap enough to actually make a good return when factoring in investments that fail for reasons that are far harder to identify ahead of time than outright fraud. The outright frauds are rare enough that checking for them needs to be very cheap for it not to be more cost-effective to spend that money improving other deal-flow filtering. That's not to say that VCs aren't trying to improve on it. It's just that fraud is just one of many risks, and managing risk is about taking a dispassionate view of which measures improve your returns the most.
      - catalogia 7y ago
        I think we should consider whether there might be a social responsibility to not fund scammers. Rather than considering the matter purely from the perspective of the investor's bank account, we should consider the broader impact of allowing scammers to find investors. It degrades the reputation of the industry every time it happens, and frankly I think it degrades society. Every time a scammer is enriched, society as a whole is harmed.
- cr0sh 7y ago
  > presumably because each of the myriad of investors assumed that somebody else was checking things Would that be something akin to the "bystander effect"?

KoftaBob 7y ago

I'm becoming increasingly convinced that because of the "spray and pray" approach of the VC model in which a small % of their investments make up the bulk of their returns, the most successful VC firms are largely the ones with the most money to spray, not due to some visionary abilities they have.

ASalazarMX 7y ago
This would explain why they hunger for explosive growth, to make up for the majority of their investments.
- WalterSear 7y ago
  It's exactly where the hunger comes from.
the_watcher 7y ago
Wouldn't this suggest Softbank as the most successful VC?

HALtheWise 7y ago

I wonder whether fraudulent startups would actually fail due-diligence checks reliably. If it is well known that investors look for certain things, Elizabeth Holmes would probably find a way to pass those checks, but well-intentioned founders might not put as much effort into compliance. From what I've seen of "compliance" paperwork in other industries, it sometimes just adds a ton of paperwork without actually preventing much fraud.