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With JP Morgan Suing a Startup Founder, Will 2023 Be the Year of Accountability?
A look at what some of the high-profile blowups of the bull market will mean for founders in a downturn.
When a founder plays fast and loose, behaves unscrupulously, or breaks the law, there are strong incentives for their financial backers to play dumb and to paper over the debacle.
Even in the case of real, dangerous scams, investors stick their heads in the sand. Theranos’s board members famously dug in their heels and defended Elizabeth Holmes as the Wall Street Journal and corporate whistleblowers revealed the company’s misdeeds.
Investors tie their reputations to their most high-flying portfolio companies. If investors were to publicly reveal that a founder scammed them, many people would focus on the investors’ failures of judgment and diligence. A venture capitalist’s financial backers would be much more concerned if there’s a big media and legal scandal than if the VC firm just notes another small washed out failed startup investment.
Taking a stand against a founder can be dangerous for an investor’s reputation and financial performance. In the case of Uber, Benchmark helped bring down Travis Kalanick. But among Uber’s critics Benchmark is just another pro-Uber venture firm. Among Kalanick’s defenders, the firm is seen as putting its brand before a tenacious founder.
When the payments company Fast was revealed to have an embarrassingly tiny business and then suddenly unraveled, investors went into hiding to try to downplay their association with the preposterous-in-retrospect startup.
Rumors always swirl but there are many exposés that never get written for lack of solid sourcing. What exactly happened that made lending company Pipe’s CEO step down so suddenly? I never got to the bottom of what happened at mental health startup Mindstrong. What was the full story behind Apoorva Mehta’s departure from Sequoia-backed Instacart? (Mehta and his subsequent company Cloud Health Systems got sued for stealing trade secrets.)
Sequoia is infamous for quietly pushing out troublesome founders without big press blowups. (Obviously, that’s not how the story played out with FTX, but again it’s not like Sequoia was the one blowing the whistle.) How many founders have Sequoia and other top venture capital firms managed out without the public ever getting wise. One of the perks in investing in private companies is that there are so few disclosure requirements. One day a company can simply announce that it’s replacing a CEO and that the founding CEO is “stepping up” to the board.
A cordially choreographed exit is often part of the deal when founders quietly step away — everyone’s public reputations remain intact.
Sometimes things go sideways and so we find out about them. When Andreessen Horowitz pushed Parker Conrad out of Zenefits, one of the assurances he got was that he’d get to go quietly. That’s not what happened. The incoming CEO David Sacks laid the company’s problems at Conrad’s feet. Similarly with Benchmark and Kalanick, Benchmark's partners suggested that if Kalanick stepped down he would avoid a public brawl with his biggest shareholders. Someone leaked the shareholder mutiny to reporter Mike Isaac anyway.
When the press uncovers wrongdoing — like in the case of the troubling Insider story about Dispo founder David Dobrik — investors will distance themselves from a company and a founder once the founder’s reputation turns toxic. Some investors gave up their shares in Dispo after the allegations against Dobrik came to light.
All this isn’t to say that venture capitalists aren’t good whistleblowers to the press. It’s just usually on deep background and generally about their rivals’ portfolio companies’ misdeeds.
Still, I’d wager that there’s more wrongdoing and sketchy behavior that we never hear about than what we do. Many of the startups with unethical founders are too small for the public or the press to care about anyway. If nobody sues anybody, these stories can be difficult to report out. Even when there’s reporting on strange behavior like at the company Tanium back in 2017, there’s not much public interest in wonky tech companies that don’t sell directly to consumers.
Of course, I wanted to discuss this culture of secrecy because I’m marveling at JP Morgan’s decision to go public and sue the founder of the student loan company Frank.
The bank bought the startup for $175 million. Then, in a lawsuit filed late last month, JPMorgan accused Frank’s CEO Charlie Javice of helping to fake millions of customers in order to induce the bank to buy her company.
The Wall Street Journal writes about the lawsuit:
Ms. Javice approached JPMorgan in summer 2021 about a potential acquisition, according to the lawsuit. She claimed Frank had 4.25 million users, the bank said. The company had fewer than 300,000 real users, the suit said, less than 10% of the stated 4.25 million figure.
“Rather than reveal the truth, Javice first pushed back on [JPMorgan’s] request, arguing that she could not share her customer list due to privacy concerns,” the bank said in its court filing. “After [JPMorgan] insisted, Javice chose to invent several million Frank customer accounts out of whole cloth.”
Frank’s investors included Apollo Global Management CEO Marc Rowan, Aleph, Slow Ventures, and Reach Capital.
While I applaud JPMorgan for holding an alleged fraudster accountable, the bank certainly looks pretty foolish for failing to notice before buying the company that so many of Frank’s customers had apparently been brazenly faked.
These kinds of lawsuits are so rare.1 I have to believe there are many cases where a public acquirer simply writes down their investment and tries to prevent shareholders from figuring out that the acquisition was an obvious mistake from the beginning.2
I wonder if founder accountability might get a jumpstart this year as the downturn in private tech continues to play out. As negative sentiment builds, there might be more open anger that some founders were so self-interested and unscrupulous. Financial backers might be more willing to go after management teams. (Of course, many founders have put their employees first and have been responsible stewards of their investors’ money. Failure is part of the startup hustle and I don’t want innocent and well-intentioned founders to feel implicated here.)
For much of the bull cycle, investors did everything they could to seem founder friendly, even if it meant looking the other way when founders screwed them over. Now that leverage is flowing back to investors, I wonder if they’ll be more willing to publicly fight founders.
There are lots of forms of poor founder behavior that don’t necessarily amount to lawbreaking.
In the bull market, some founders made a fortune cashing out their shares long before their startup built a sustainable business. Now some of those CEOs aren’t putting in the hard work of delivering a good outcome for shareholders.
Founders can raise structured financial rounds or position an exit so that it advantages them over other shareholders.
Founders can spend their corporate coffers lavishly and blow through money that they raised without a real plan, instead of returning it to investors.
Of course, one of the reasons that Silicon Valley is able to pump out successful companies despite the culture of secrecy is that there are private whisper networks. Elite investors talk. And now they’ll have more time to with deals taking weeks, not days.
During the bull market, investors — facing competition from loose money like SoftBank and Tiger Global — rushed their diligence and reference checks.
Now that dumb money is drying up, the remaining investors should have more time to figure out which founders screwed over their investors and employees before investing in their next company or subsequent funding round.
I believe in transparency and public accountability, so I’m hoping that more wrongdoing makes its way to the public. Otherwise only investors with access to those backroom whisper networks have the information they need to avoid bad actors. The cult of the founder created some enormous tech companies, but it’s also gotten out of hand. If a bank like JPMorgan is willing to draw attention to its poor diligence and sue a founder, hopefully other stewards of capital will be so bold.
As always I’m eager to hear from you if you’ve got a juicy tip or a story that I should chase down. You can reach out to me at email@example.com and I’ll give you my phone number so we can talk or text on Signal. I’m happy to honor requests for confidentiality.
Dan Primack’s writeup in Axios muddies the water on JPMorgan’s thinking here somewhat. Primack writes, “My understanding of the situation is that JPMorgan likely would have let the entire thing slide under the rug, had Frank founder Charlie Javice not sued first.” If that’s true, it seems like a terrible strategic decision by Javice. She’s only hurting her public reputation in a legal fight with the bank unless major new facts come to light.
And some of the most expensive frauds have largely been forgotten by this generation of founders. In 2018, a jury found the chief financial officer of the company Autonomy guilty of fraud after Hewlett-Packard spent $11 billion buying the company in 2011. In Jan. 2022, Hewlett-Packward won its civil fraud case against Autonomy CEO Mike Lynch. The legal system can be extremely slow but legal consequences are possible.