The venture and startup industries have long had a problem with transparency.
Theranos could have likely saved itself from a future fraud trial if it was honest about the shortcomings of its blood testing device. Nikola founder Trevor Milton probably wouldn’t be on trial right now if he hadn’t allegedly lied to investors in a 2017 video that showed the electric truck his company was building was operational when it wasn’t.
In today’s market, with venture coming off an incredible bull run right into a downturn, it’s especially hard to keep up with what’s fact and what’s hype because the data hasn’t matched the discourse.
Venture capitalists said a market dislocation is the best time to invest, and yet funding continues to decline despite record levels of dry powder — and founders are taking note. Startups have laid off staff in droves due to market conditions weeks after raising fresh funds or right before making an acquisition.
Transparency would help every layer of the venture capital stack. As this market dynamic looks poised to produce stark winners and losers, it’s more important than ever for founders and firms to be transparent if they want to emerge from this downturn in good standing with the community and their employees.
Murky miscommunications
Launch House, a community-oriented startup, is a perfect example of this.
The startup was recently the subject of a Vox article that outlined allegations that the company was riddled with security issues and tried to cover up instances of bad behavior, including sexual assault by its members. When the article came out last weekend, many of the company’s backers said they were hearing about these issues for the first time despite some of the events taking place well over a year — and multiple financing rounds — ago.
Investors like Mike Dudas, a general partner at 6th Man Ventures, posted a Twitter thread — that has since been deleted — to say he was devastated by the allegations against the company and expressed frustration about only hearing of the incidents through the story.
After the allegations, Launch House said it would hold a town hall to answer its community’s questions and provide a framework for a path forward. The 10-minute internal call didn’t allow for questions — and subsequently didn’t have the desired result. The startup has since apologized for how it handled that call and announced additional meetings to allow community members to ask questions, according to an internal message reviewed by TechCrunch.
While, yes, some investors probably wouldn’t have continued to support Launch House if they knew about the allegations at the time, it’s clear some would. An angel investor in the company, who spoke to me on background, said that they actually knew of many of the incidents when they happened through friends going through the startup’s program. They added that they were satisfied with how the Launch House team handled the incidents and the safety and security precautions implemented after. But a botched delivery can override the message.
“I generally think they’ve made the right calls in the situations that I’ve heard about,” the investor said. “I don’t think Launch House has done a good job of informing investors about potential scandals for the extent they have tried to address them. They haven’t been proactive.”
If Launch House had been transparent with their investors as things happened, and about what they did to try to prevent them from happening again in the future, the Vox article would have sparked a very different conversation.
Vulnerable valuations
On a less drastic note, for some reason, venture capitalists are still not being transparent with their LPs about the value of their portfolios.
I reported a story recently about how venture firms should be auditing their portfolios because they are likely overvalued, which can cause problems with their LPs. At the time, Susan Spears, an investor at Atento Capital, which is part of the George Kaiser Foundation, told me that she doesn’t really get why investors are avoiding having that conversation with their LPs. It’s not like they can’t read the headlines about company layoffs or see where the market is trending.
“I am a huge advocate of ‘communicate good news fast and bad news faster,’” Spears said at the time. “A lot of fund managers are sitting on their hands because they are nervous on how to communicate to LPs. Be smart about it, but it’s more important to get it out there. We understand it’s a cycle and it’s going to be tough. We know that and we want to be partners with our GPs.”
Do venture investors really think their LPs believe that, despite a marketwide downturn, their portfolio has stayed the same from last year? Good luck with that.
Rob Go, an investor at NextView Ventures, outlined it beautifully: “At some point you look like an idiot,” he said. “Everyone is sort of in the same boat. You can mask it for a long time, but not forever.”
Plus, as the piece mentioned, not properly marking down your portfolio can cause balance sheet issues for your investors, which may sour a future relationship with them. Just this week, board meeting documents from the Florida State Board of Administration’s investment advisory committee showed the toll of an overvalued portfolio.
The institutional investor said it had been working with the state legislature to see if it could raise the amount the LP could allocate to alternative investments — which houses its VC commitments — because it was approaching its 20% legal limit due to market conditions, which could potentially prevent the LP from making the rest of its planned commitments this year.
I’m sure that portfolio needs a valuation check, but what can it do? Meeting documents show that earlier this year, the venture portfolio had two straight quarters of more than 100% IRR. Now they have to ask their state legislature to allow them to invest more. If their private portfolio was marked to market, their allocations wouldn’t be.
Aloof acquisitions
As a journalist covering the startup space, one more note: Tell us how much you paid for that startup!
Startups acquiring other startups is on the rise, but so far we’ve seen a lot of transactions with an undisclosed purchase price. I have to be honest: This instance of a lack of transparency surprises me the most.
In a time where everyone is predicting weaker companies won’t survive and that many of the acquisitions this year will be of startups that would have otherwise gone out of business, if you bought a company because they are actually doing well … why not say it?
Sure, of course, we assume at least the buyer and seller do know those metrics — but think about the employees. All year, startup employees have watched their colleagues and friends get laid off, if they weren’t let go themselves. Was that company getting bought doing well? Is there something to learn about the health of a startup’s industry? The people want to know.
You wouldn’t want a potential hire to not apply to your startup because recent activities made them unsure about the future health of the business or the viability of the sector.
Transparency builds trust. Venture capital is an industry filled with people who have long memories — even if they sometimes ignore them. How transparent firms and startups are now as things are tougher will determine how the broader community feels about them when things start heading up and to the right again.