Falling in love with the New Kids on the Block
Investors went gaga over Elizabeth Holmes and Sam Bankman-Fried for different reasons but gave both young, first-time entrepreneurs way too much slack to their peril.
There is another angle to the whole FTX drama that is worth discussing. From an investment standpoint, the elephant in the room is why some of the most sophisticated investors in the world put money in FTX without doing the required due diligence. There were plenty of red flags, including that FTX had no outside board members and the founders were left operating in the shadows.
We believe Elizabeth Holmes’s behavior was much less nefarious than Mr. Bankman-Fried. She didn’t run off with customer and investor money and spend it on extravagant properties and political causes and bail out a hedge fund she started, as was the case with Mr. Bankman-Fried. She was also only handling sophisticated investor money. These investors knew she was a first-time entrepreneur and CEO, therefore, were complicit in her downfall by not requiring her to meet the typical transparency and reporting requirements. Theranos investors were also guilty of falling for the ‘too good to be true’ paradigm shift pitch. In the end, Ms. Holmes was a casualty of schadenfreude. The entrepreneurial process is a high-risk business, and as early Theranos investor Tim Draper says, ‘If things don’t work, you take your lumps.’
The answer to this question is similar to why investors got burned in the Theranos deal — a religious zeal to invest in founders who fit their political and social ideals.
FTX raised $500 million in the year up to the FTX collapse with a take-it-or-leave-it pitch, where Mr. Bankman-Fried proclaimed it was his company he would run with little oversight and interested investors should ‘support him and observe.’ While pitching to Sequoia Capital, he reportedly played a video game during the meeting. Sequoia was so impressed with Mr. Bankman-Fried — one partner breathlessly described it like he was ‘talking to the world’s first trillionaire.’
After a meeting that left the partners in awe, Sequoia invested $214 million in the deal. They also published a glowing profile on Mr. Bankman-Fried on their website with the headline, ‘Sam Bankman-Fried Has a Savior Complex — And Maybe You Should Too,’ with the tagline ‘The founder of FTX lives his life by a calculus of altruistic impact.’ You couldn’t make this shit up.
Mr. Bankman-Fried and Elizabeth Holmes wanted to save the world, and they used their charisma to draw dreamy-eyed investors into their altruistic dreams. Mr. Bankman-Fried was preaching a vision he shared with his top lieutenants called ‘Effective Altruism, a philosophy of using logic to set about ‘doing good better.’ Ms. Holmes positioned herself as ‘the female Steve Jobs,’ complete with her closet full of black turtlenecks.
Upon closer examination, it is clear that Mr. Bankman-Fried’s ‘idea of doing better’ meant funneling tens of millions of customer and investor money into political causes and positioning himself as the next George Soros. And thanks to VC funds supplied by Sequoia and the legions that followed, he achieved his goals—at least for the last election cycle. The list of A-list celebrities and politicians he paid off to gain influence and status is so exhaustive that it is hard to know where to start.
Let’s start with the first ticket one needs to buy to rub shoulders with the political elite — an invite to the Clinton Global Initiative. After all, that’s how Elizabeth Holmes jumped into the arena. To earn his ticket to CGI, Mr. Bankman-Fried paid Bill Clinton $250,000 to speak at his FTX’s Crypto Bahamas Conference last April. Shortly after, Bill and Hillary Clinton invited Mr. Bankman-Fried to speak at their next annual Clinton Global Initiative in New York. This endorsement quickly elevated his reputation amongst the political elite.
To further polish his political CV, Mr. Bankman-Fried donated more customer and investor money to all the prerequisite causes like pandemic preparedness and climate change. In addition, he threw in another $38 million to fund ‘progressive’ political candidates and mostly left-leaning super Political Action Committees to fuel the 2022 midterm elections. According to CoinDesk, 196 members of the new Congress took cash from Mr. Bankman-Fried or other senior executives at FTX, including new Speaker of the House Kevin McCarthy and Senate Majority Leader Chuck Schumer, the Democrats’ Senate Majority PAC, and Beto O’Rourke’s failed Texas gubernatorial campaign.
FTX also reportedly set up a website, Aid for Ukraine, to raise funds for Ukrainians amid their ongoing war against Russia. The Ministry of Digital Transformation of Ukraine, FTX, and Ukrainian web company Everstake powered the initiative. Donations to Ukraine came from their native FTT token sent to the National Bank of Ukraine. Fortunately for the Ukrainians, they converted the crypto donations into fiat in March, well before the crash, according to a tweet by Deputy Minister Alex Bornyakov.
Mr. Bankman-Fried’s effort to stash money with all the right people made him a major player in Washington and gained him invitations to fashionable celebrity-filled parties. All this sprinkling of other people’s money also went hand-in-hand with FTX’s effort to lobby Congress for favorable policy treatment for the company.
Most politicians who responded CoinDesk about their tainted contributions said they handed it over to charities. But charities may not escape the reach of FTX’s bankruptcy case and be subject to clawbacks. ‘The law does not care if you gave it to Mother Teresa,’ says Anthony Sabino, a bankruptcy expert and law professor at St. John’s University. The Clintons have remained silent since they will argue the speaking fee was not a political donation (yeah, right).
In the finest Soros tradition, Mr. Bankman-Fried plowed FTX cash into left-leaning media outlets, including The Intercept, Vox, ProPublica, and former New York Times media columnist Ben Smith’s new outlet, Semafor. He also reportedly owned $100,000 in the pre-Elon Twitter public stock.
All combined, Mr. Bankman-Fried was the second most prolific funder of left-leaning candidates and groups after Mr. Soros. It will be fascinating to observe to what degree Mr. Bankman-Fried’s political investments will impact how his trial plays out and how government agencies treat him and FTX. On the one hand, the many politicos and organizations he backed owe him big. But, at the same time, the right will want to signal to anyone who aspires to be ‘the next George Soros’ that they will do anything to stop them in their tracks.
It is very evident to us that there were, indeed, other reasons sophisticated investors abandoned traditional due diligence before investing in FTX for the higher purpose of being a ‘Savior’ and ‘living a life calculated by altruistic impact.’ Were investors in Theranos deal more reckless in the due diligence process because Ms. Holmes was a young woman in a black turtle neck? Absolutely. And unfortunately for Ms. Holmes, she will be living behind bars, while her equally culpable investors will be noshing and sloshing in the Hamptons.
As noted in our last post, Twitter is another twist on the same theme. Twitter senior executives lost member trust by managing the network according to their political ideology, leaving its public investors with a stock price trading below its 2003 IPO valuation. The board then had to sell Twitter to Elon Musk, who offered a price above the IPO because the company had become a failed business.
Investors need to be careful the vision of the founders they bet on addresses real consumer or business problems in existing markets with some evidence of growth potential. Funding the early development of a new, unproven market can be a very expensive proposition. Benchmark’s Bill Gurley also warns, ‘The most dangerous scenarios are the ones where the company claims a significant paradigm shift. Founders, employees, and investors intent on disrupting the status quo start believing in a new reality even without empirical evidence or actual results.’
‘There is a fine line between the madman and the genius. Both require a rich fantasy life; to be the latter requires keeping at least one big toe firmly on the ground.’
— Anthony Storr, British psychologist, in his book, Solitude A Return to the Self
Having grown up interviewing and knowing well the founder of Sequoia Capital, the late Don Valentine, the original gangster of VC — we can assure you he is rolling over and in his grave. The one question you needed to prepare for if you pitched Mr. Valentine was, ‘Who cares?’ He would have walked out of the room if you played a video game during your pitch. If you wanted $215 million of Sequoia’s money, it would be on the condition that he would be Chairman of the Board. He would also advise entrepreneurs to leave their politics at the door because there is a business to run. In other words, if Mr. Valentine were alive today, Sequoia Capital would have an extra two hundred million in the bank and probably saved much of the additional $1.8 billion that the VC herd who loves to follow Sequoia plowed into FTX.
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