Many startup founders and certain types of scammers often have a similar mentality.
The last few weeks I’ve been watching a number of TV shows about scams including Bad Vegan, Inventing Anna, Tinder Swindler, and Devoured S1 E5 Deli Wars (about the famous Carnegie Deli). In the past I’ve watched Fyre, Fyre Fraud, and Rogue Trader. Some were actual documentaries, while others, like Inventing Anna, were dramatized versions of the story. Having spent decades in and out of cybersecurity I’ve also had training, formal and otherwise, in social engineering, a technique used by malicious hackers and scammers alike.
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The people who are the heart of the scams generally fall into one of two camps. Some are out to simply get money. They know they are lying and don’t care, so long as it gets them their end goal, typically someone else’s money. This was the case with Charles Ponzi, the inventor of the Ponzi scheme, Simon Leviev (Tinder Swindler), and Bernie Madoff. They know they live in a world of lies and simply hope to outrun the consequences.
On the other hand, you have people like Anna Sorokin and even to some extent Billy McFarland (of Fyre Festival infamy) likely had a slightly different intention at the outset. Both had dreams of grandeur. Both undertook the philosophy of “fake it ‘til you make it” (a philosophy I have never condoned). They believe that if they could bluff their way to getting things moving, success will follow and, in the end, there would be enough money for everyone, themselves and all the debts they create along the way.
I don’t mean to suggest they weren’t motivated by money or influence for themselves; they were. But at some point in the process (typically the outset, but not necessarily the whole time) they believed it could still work out. Consider, Simon Leviev was regularly trying to stay one step ahead of the law. He knew when to cut and run. Billy McFarland actually showed up to the Fyre Festival despite the lack of preparations. If it was just about stealing money, he should have left with a suitcase full of cash. Likewise, Anna Sorokin planned on running a private club in midtown Manhattan. The money was going into that building; while she may have planned to skim off the top and run it seemed more likely that what she wanted was fame and influence and she was going to sit on her throne. (To be fair, I haven’t spoken to any of them, so you’d be justified to question this argument. Maybe they were scammers just like the first set and simply not smart enough to cut and run in time.)
A founder must believe it will all work out in the end.
What does this have to do with founders? I’ve had a view into many startups, as an executive, potential hire, consultant, and potential investor. Every founder I’ve met has sincerely wanted to create a successful company. Whether their goal is to change an industry or just get rich, they have sought funding to legitimately grow the business, ultimately increasing shareholder value.
But it’s never an easy path. Even in the best of times every founder needs to be optimistic. As founders face non-stop rejection (no I won’t buy your product, no I won’t invest, no I won’t partner with you, no I won’t join, no, no, no!) they need to have some irrational exuberance. A founder must believe in the successful future even if the light at the tunnel is hard to see. A founder must believe it will all work out in the end.
When things get tough, often with the loss of customers or running into financial difficulty, founders still need to be optimistic. I can think of more than one case of a founder hiring employees selling a picture much rosier than others at the company would have described it.
It’s a fuzzy line. Misleading investors with financials is bright line fraud. Unfortunately, misleading employees does not seem to be, even if those employees get equity. (If it is technically illegal, I’ve never seen anyone prosecuted for it unless it was linked to defrauding investors.) What about a founder touting some great partnerships, even if those partners have indicated dissatisfaction and are likely to cancel the relationship very soon? I’ve seen other IP overvalued as well. How about showing overly optimistic financial projections that are as likely to come true as hitting the lottery—sure it’s technically possible, but the odds are very thin. Time and again I’ve seen founders express a level of optimism not dissimilar to that of some of the subjects of the shows above.
Time and again I’ve seen founders express a level of optimism not dissimilar to that of some of the subjects of the shows above.
Naturally we need to consider Elizabeth Holmes, the founder of Theranos on trial for defrauding investors in her company. She’s no fool. Holmes dropped out of Stanford to found Theranos. She’s smart enough to have understood that her net worth would be based on her shares, which she could only sell after an IPO or exit. Both of those would require the company growing which means repeat customers using functional products. There was simply no way for her to make millions from her salary alone since it would be visible to the board.
I don’t believe when she left Stanford in 2004 that her intention was to defraud investors. I have no doubt she really believed in the potential of the company. Along the way the lofty goals far exceeded the realities of engineering. The testing was being done by equipment from other companies. This is, I suspect, not because this was her plan all along, Theranos had a significant scientific and engineering team, but rather a stop gap until they could have their own technology do what they promised. Fake it ‘til you make it. Along the way, with her back to the wall, she crossed the line and actively misled investors. In the end, her story isn’t that dissimilar to Sarma Melngailis (Bad Vegan), Columbia educated founder of the acclaimed Pure Food and Wine restaurant who had a similar downfall (even if the root causes of why they perpetrated the fraud were different).
I’m in no way defending the actions of anyone named here. Quite the opposite. Legally those who commit fraud should be held accountable. I’d say the same is true for those who cross the line if only ethically, but not legally. The reality is there are very few consequences and many startup founders come dangerously close to, or even cross the same lines we see in these better-known stories of fraud. To anyone investing in startups or taking equity: caveat emptor.
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