Chamath Palihapitiya, a well-known venture capitalist, claims that his team offered some suggestions when he was asked to take part in an FTX financing round. They included common safety measures for venture investors, such establishing a board of directors and offering some representations and guarantees. The employee of FTX said, “F—- you!”
This shows that some protections that Palihapitiya’s Social Capital fund believed were crucial based on prior experience were not demanded by the A-list VC investors who did finance Samuel Bankman-Fried. Historically, when standards have declined, it has usually been because there is too much money pursuing too few opportunities. Excessive demand may have occurred in recent years as a result of institutional investors increasing their allocations to venture capital as they became aware that the expected returns from stocks and fixed income weren’t enough to cover their future obligations.
Whether FTX was a singular instance of VC gatekeepers falling in love with a seductive entrepreneur is unknown. If that’s what actually occurred, it’s not the only instance in recent years. Billion Dollar Loser: The Epic Rise and Spectacular Fall of Adam Neumann and WeWork by Reeves Wiedeman (2020) details how a charismatic CEO was able to acquire a wholly erroneous super-tech value for a corporation engaged in the unremarkable activity of renting out office space.
Jeff Stambovsky, a former coworker of mine, suggests the following argument as to why FTX was successful in persuading VCs to relax their guard:
Do not undervalue the significance of SBF’s standing within the Effective Altruism movement. SBF was aware of the levers to pull in order to elevate the self-esteem of big investors.
Miscalculations made by venture capitalists may harm markets. Another former coworker, Rick Bookstaber of Risk Fabric, recently used humour to make a serious point on this topic. He explained how it was feasible to build a $50 billion firm relatively immediately as follows: Create a billion shares, then sell 100 of them to a kid of yours for $50 apiece. The youngster will pay you back with a loan. Calculate, advises Bookstaber.
It is serious business because an investor with impaired judgement might artificially inflate the whole enterprise value of a private firm by purchasing a tiny portion of its shares. Differences between idealised ideals and values based on reality might have negative effects. As an illustration, several VC funds are presently facing criticism for failing to significantly mark down their holdings in the wake of this year’s sharp declines in the indexes of publicly traded firms. As a result, institutional investors in those funds can have exaggerated perceptions of the value of their portfolios.