A few people in the comments sections of my recent videos about the whole situation at
FTX are acting like these videos are designed to be funny, or that they are comedy of some
sort, and that is just not true, and it is a mischaracterization of my YouTube channel
and what I’m trying to do here.
Today I’m going to be talking about the venture capital firms that invested in FTX,
and so to a certain extent I have to rely on one of the documents from Sequoia (one
of the big Tech VC firms) websites (that they have since deleted.)
This document explains the thought process around their investment, which they were clearly
very proud of only a few weeks ago.
Now look, there is stuff in there like the bit when SBF pitched to the partners that
his vision for FTX was of a super app.
“You can buy a banana, you can do anything you want with your money” Sam allegedly
said to them while dressed like an unruly toddler and playing video games.
But, that’s not a joke (it is just what happened – It’s in the document – and
it was deemed relevant by the partners at Sequoia as otherwise they wouldn’t have
publicized it on their website), and we are not really going to learn much about Technology
Venture Capital investing here, if people are just going to snicker about things like
this in the comments section of my videos.
In California, particularly in Silicon Valley, online cryptocurrency trading and banana procurement
are the kind of problems that still need to be solved, and to many in the Venture Capital
space, Sam Bankman Fried looked like the man who would solve that problem.
This banana statement from Sam apparently blew the partners away.
The document goes on to explain that what Sequoia was reacting to – wasn’t just
the idea of getting a banana - it was the scale of SBF’s vision.
This wasn’t a story about how we might use fintech in the future, or crypto, or a new
kind of bank.
It was a vision about the future of money itself—with a total addressable market of
every person on the entire planet.
That is what they say…
And, that really is the thing, a crypto brokerage might have a market that is capped at a certain
size (there are only so many people interested in trading cryptocurrencies and wealthy enough
to trade cryptocurrencies), but almost everyone on the planet would consider eating a banana.
And it’s not just people either, monkeys love bananas, and for all we know maybe a
monkey would happily give you a bitcoin which is worth around $16 thousand dollars for a
banana, as monkeys have no use for bitcoins, and they love bananas.
Sam was singing the VC investors a song they wanted to hear, and he was doing it while
playing video games.
I think we can all agree that – in truth - the partners had the wool pulled over their
eyes by Sam, who at no point appears to have transacted in bananas after taking their investment
and we don’t yet know if any monkeys have found themselves facing financial hardship
after opening accounts at FTX.
The press just aren’t talking about that.
So anyhow, like I said… this is a serious video, and if you think it is funny you just
don’t understand how things work in Silicon Valley, and that is your fault, not mine.
I have been doing my best to explain it.
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OK, so, according to Sam, what happened next at FTX was a simple 8-billion-dollar mistake.
There has been no real explanation as to what exactly happened with the customer funds that
have gone missing.
The closest thing to an explanation that we have is a tweet from Sam saying that the issue
stemmed from a poor internal labeling of bank related accounts.
Now of course if that was the case, I would imagine that some quick re labeling could
have occurred, and then everything would have been fine, but a relabeling solution is starting
to look less and less likely right now as many of the FTX employees have reportedly
fled the Bahamas, some even abandoning their cars at the airport.
That is the thing with “Gen Z”, a bit of labeling work turns up, and suddenly there
is no one to be found.
But anyhow…
Now, of course, while people do make 8-billion-dollar mistakes all the time…
It is likely that we are instead looking at a huge fraud.
The bankruptcy filings state that the company’s management used software to conceal the misuse
of customer funds.
That, on it’s own is fairly damning.
While it is totally reasonable for Sam to have lost his own money, and the money of
the VC investors, there is no reason that customer funds were ever touched.
Sam appears to have invested in Robinhood and in Twitter, money was spent on sponsorships
and given to politicians.
Money was invested into the very VC funds that invested in FTX.
Shouldn’t the venture capital funds have considered it a bit strange that Sam had enough
money to invest with them, but was asking them to invest in his firm?
$300 million dollars worth of real estate was bought by FTX which was used as homes
and vacation properties for FTX executives.
Sam’s parents – two college professors bought property in the Bahamas worth 121 million
dollars.
On top of all of this Sam bought a Toyota Corolla to demonstrate how humble he is.
So, which venture capital firms invested in FTX and why?
Well, Tiger Global- as an example, was an early investor.
They first invested in FTX in a Series A round in 2019, which raised $8 million.
Tiger would later go on to invest in two more rounds.
Others in the Series A included Lightspeed Venture Partners, Temasek, and Binance Labs.
Oh yeah and of course there was Softbank too…
After raising 8 million in 2019, the pandemic struck in 2020 and people stayed at home and
traded cryptocurrencies, by July 2021, in a much hotter market, FTX was able to raise
a billion dollars, with additional brand name investors including Third Point Ventures,
Coinbase Ventures, and Thoma Bravo.
Orlando Bravo – the founder - had been a student of Sam’s fathers at Stanford, and
was excited to invest with his professors son.
In October 2021, FTX raised a meme round of $420 million dollars from 69 investors (both
of those numbers are considered lucky in Silicon Valley).
This capital raise valued the firm at $24.5 billion.
Tiger Global was in that round, as was Lightspeed, Temasek, and Senator Investment Group — along
with dozens of others.
It wasn’t just sophisticated investors who put their money in either, Kevin O’Leary
invested too.
The most recent fundraising round occurred in January of this year, as crypto had already
begun it’s fall.
The $500 million Series C, which valued FTX at $32.5 billion, included investors like
SoftBank, Lux Capital, Tiger Global, Lightspeed, and Temasek, among others.
Now that FTX has filed for bankruptcy, these investments appear to be entirely gone.
Many of the investors have marked their holdings in the company to zero.
These investors will be stuck facing tough questions from their investors about how they
missed all of the red flags.
They’ll have to explain why they didn’t demand board seats, and what exactly their
analysis involved.
Over the last year we have seen that it is not just retail investors who experience FOMO.
The Financial times interviewed a few VC investors, who didn’t give their names.
One claimed to have been “seduced,” He said that with hindsight, he thinks that when
his firm questioned SBF before investing, they should have focused more on the details
about the crypto exchange’s governance and financial controls — rather than being blinded
by its founder’s snowballing celebrity profile.
He went on to say that he had some reservations during initial calls with SBF, including the
way Sam “comported himself” and the sense that Sam believed everyone else in the financial
world “were idiots”.
Another venture capitalist said that due diligence did not reveal the high levels of leverage
in the business — he claimed that investors were only shown the balance sheet at quarter
end and the leverage was not on it.
It is normal for VC investors to ask for a seat on a portfolio company’s board, in
order to monitor their investment and have some control, but at FTX, none of the investors
had board representation.
The three-person board of FTX consisted of Sam Bankman-Fried; Jonathan Cheesman, a former
FTX executive; and Arthur Thomas, a lawyer in Antigua who specializes in online gaming.
With startup investments, VC firms are often most worried about a product failing.
They give a founder a lot of money to build out a business, and the risk is that the founder
either builds a product that doesn’t work or that there is no market for.
VC’s are used to dealing with businesses that might have sloppy accounting and bad
governance, as that is often the nature of investing in startups, but often the VC firm
brings this type of professionalism to the table.
They put their own people on the board and get financial reporting “in order” in
time for the company to go public.
Tiger Global, who I mentioned was one of the first investors in FTX had a reputation for
being a founder friendly investor who moved fast and did less due diligence than other
investors – they reportedly closed one new investment per day last year!
Tiger hired the consulting company Bain & Co. to do due diligence on FTX.
In fact, Bloomberg reports that Tiger pays Bain more than $100 million a year to do research
like this for them.
According to a number of investors Sam Bankman-Fried’s pitch to investors was not much of a pitch:
It was a take-it-or-leave-it offer.
The New York Times reports that the pitch was - that FTX was Sam’s company, and he
planned to run it with little oversight and interested investors should “support him
and observe.”
One investor apparently asked Sam to put together a presentation.
The presentation was allegedly thrown together in PowerPoint in a few hours.
“There was no formatting, the fonts were all mixed up.
The story goes that the investors were a bit uncomfortable that so little effort had been
put in to explaining the business, but they invested anyhow.
Andreessen Horowitz one of the big VC firms did pass on investing in FTX in part because
its partners didn’t trust Sam.
Elon Musk claimed that he turned down an investment in Twitter from Sam as he had an instinct
that something was wrong about him.
Based on statements in the bankruptcy filing, it now appears that this may be untrue and
that Sam owns a $100 million dollar stake in Twitter.
For years VC investors have been reducing their standards and stripping away requirements
that give them control over a company and protect their investment.
This is what they say they have to do to get into the hottest deals.
There is an argument that you might not be making the best investments in such situations.
We have in recent years seen venture capital firms get excited about investing in firms
like We Work – where they somehow got confused that a coworking space with a beer tap was
a technology startup.
Last year’s investment manias in cryptocurrencies, tech stocks and the SPAC boom only intensified
this trend.
Venture Capital Investors viewed FTX as a way to dip a toe into cryptocurrency without
buying risky coins or tokens.
The idea being to invest in the casino rather than gamble at the tables.
They often viewed FTX as a safer bet than Binance, since FTX had pushed to establish
some sort of regulatory regime in Washington while Binance had drawn controversy by dodging
financial regulations around the world.
So how bad is the performance at these funds?
Well, it is difficult to say, as a lot depends on their overall portfolios.
They will have invested in all sorts of other startup firms that are difficult to value.
It is probably a good guess that they are not doing that well, as public tech stocks
and unprofitable companies have not been having a great 2022, so it’s reasonable to assume
that their overall portfolios might be correlated to an index like the Goldman Sachs Non- Profitable
Tech Index.
But it is important to realize that they won’t be wiped out by their losses in FTX.
Venture Capital is actually designed to take big risks that often fail.
Sequoia, an early backer of Google, PayPal and WhatsApp, had $210mn invested in FTX,
they went on to become Sam Bankman-Fried’s biggest cheerleader.
That position made up less than 3% of just one of their funds.
Other VC funds will have had similarly low allocations to FTX.
So, while you might read about them losing large dollar amounts, and being victims of
this fraud, the loss is usually a small percentage of their overall portfolios.
One issue is that these high-profile investors gave a certain respectability to FTX, a respectability
that it didn’t deserve based on the way it was being run and the lack of supervision
by these name brand investors.
FTX customers are likely to have lost significantly higher percentages of their wealth when the
firm collapsed two weeks ago than the venture capital funds did.
FTX marketed to retail investors that they should have their pay checks deposited directly
into their FTX account.
This would have been a disaster to anyone who followed that advice.
Because of the collapse of FTX, there is still no super app where “You can buy a banana
and you can do anything you want with your money.”
Who knows what wonders the future might bring.
If you have a great idea for an app like that, do let me know about it in the comments section,
and I don’t want anyone making jokes down there this week.
If you enjoyed this video, you should watch my video on blitzscaling next, which looks
at how startups like Uber and WeWork can set VC money on fire while trying to grow.
Don’t forget to check out Blinkist our video sponsor using the link in the description
below.
Have a great week and talk to you again soon, bye.