Blue chip investors’ relations with LPs and regulators have been strained by the FTX fiasco.
They are now trying to save face and promising to do better next time around.
This, as the U.S. Securities and Exchange Commission (SEC) is reportedly investigating the due diligence approaches of some of the failed cryptocurrency exchange FTX’s biggest equity backers.
Alfred Lin, the partner responsible for leading Silicon Valley venture capital (VC) firm Sequoia Capital’s investment in FTX, posited Thursday (Jan. 12) at an industry event hosted by the newsletter StrictlyVC that his firm was “misled” by Sam Bankman-Fried and FTX.
Sequoia, which invested $150 million from its $6.5 billion growth fund and $75 million from a separately managed hedge fund into FTX, had previously apologized to its investors for its loss in the fallen cryptocurrency exchange FTX and said it will step up its due diligence for future investments.
“We asked, ‘Are these two companies independent?’ and we were told that they were,” Lin said at the industry event this week in reference to the tangled relationship between FTX and its sister trading firm, Alameda Research — whose poor bets are allegedly at the center of the FTX implosion.
Alameda Research was reportedly not included in an organizational chart given to Sequoia by FTX that was meant to outline its corporate architecture of subsidiaries, despite FTX founder Bankman-Fried owning 90% of the trading firm.
The VC fund has since written down its total $225 million investment in FTX to zero.
Alameda Research CEO Caroline Ellison has pleaded guilty to criminal charges of fraud and is cooperating with authorities in their investigation of the FTX collapse and her one-time boss, Sam Bankman-Fried.
“What gets me is not that we made the investment,” Sequoia partner Andrew Lin said. “It’s the year-and-a-half of working relationship after the investment and I still didn’t see it — and that’s difficult.”
Could the Backers of FTX Have Done Better?
The quick and easy of it is yes, they could have.
Sequoia Capital has long been considered one of the world’s most preeminent investors, particularly within tech-driven Silicon Valley. Where Sequoia goes, other VC firms tend to follow.
The firm’s five-decade-plus history boasts early investments in Apple, Alphabet’s Google, Airbnb, YouTube, WhatsApp, Shein, Dropbox, Stripe and many other sector-defining companies.
The windfall from those successful exits makes the write down from FTX just a miniscule drop in a very large bucket, but the storied VC’s lax approach to backing Bankman-Fried’s crypto company may still be reason enough to give its equally impressive list of LPs pause.
“A hundred fifty million dollars out of a $6.3 billion fund, if you lop off some zeros, one zero, it’s $15 million out of a $630 million fund,” Lin said. “If you look at it that way, which is how we looked at it from a risk management perspective for Global Growth Fund III, we can take a $15 million loss on a $630 million venture fund.”
As PYMNTS’ Karen Webster wrote on Nov. 14, during an investor pitch to the Sequoia partners via Zoom in July 2021, the firm’s partners fixated on the fact that Bankman-Fried was answering their questions while in the middle of playing a video game. Declared a multitasking genius, the disgraced founder was described in a since-deleted Sequoia profile as a “10 out of 10.”
“Am I talking to the world’s first trillionaire?” the profile’s author asked a Sequoia partner, who replied, “Yes, I think [SBF] has a real chance at that.”
The profile no doubt inspired a sense of fear of missing out (FOMO) within the investing community.
Just a year later, Bankman-Fried’s net worth and the value of his company would both shed tens of billions of on-paper dollars on their way down to zero.
Industry Blinders
The mission of a VC firm in deploying its funds is not necessarily about avoiding failure — rather, the focus is on not missing out on the next big thing.
The success of one big bet like an Apple or a Google, after all, can support the loss of 50 other bad bets, like a Juicero or even an FTX.
The nature of the industry means that, generally, investors have to operate with limited information when investing in the early stages of a startup’s roadmap. It is an inherently risky proposition — and as VC’s mainstream popularity has soared in recent years with hedge funds and big institutional investors entering the space, competition to find the “next big thing” has become frothier.
To be sure, FTX’s growth was fueled by a Wild West-style environment where companies knew that if they turned down a founder like Bankman-Fried, dozens of other investors would step up and open their checkbooks.
It remains to be seen whether the industry can shift the balance of power away from chasing so-called “cool kid” (or inexperienced) founders toward calmer seas where patience and ironclad diligence are rewarded.
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