VC-backed startups commit more fraud, and researchers think they know why

“Investors set the high growth expectations,” Weiss continued. “Founders then do the necessary and present the numbers and outcomes that investors want to see.” 

Investors may play another role: The UT report suggests that being accused of fraud is hardly career-ending in Silicon Valley. It found little evidence that alleged fraud prevents founders from raising funding for new startups — even if those fraud cases received major media attention.  

“New investors and the broader VC market do not penalize past misconduct,” the UT report said, which is “also consistent with the Silicon Valley culture that embraces failure regardless of the cause.”  

The study also found that startups whose boards were controlled by the founders were twice as likely to commit fraud compared to those with investor-controlled or shared-controlled boards.  

Even more interesting, it reports that after such startups go public, when they maintain founder control, they are more likely to face securities class-action lawsuits within two years than PE-backed companies that go public.

The fact that companies are staying private longer also contributes. Public companies undergo more scrutiny than private ones. “Founders do not have a professional body or association that could govern or enforce rules of entrepreneurial and investor conduct on how to be a good founder and what reasonable growth expectations are,” Weiss said. 

Weiss proposes that the SEC should start investigating and conducting formal audits on startups routinely after they hit a large “investment threshold,” he says. Currently, the SEC typically waits for something like a whistleblower complaint or a lawsuit from investors or former employees to trigger an investigation.

Weiss’ paper suggests that investors should take more accountability when pushing founders to hit extreme growth metrics.

“Investors should be held liable for corporate governance failures and violating their fiduciary duties,” he said. He wants to see more research into “entrepreneur-investor dynamics” that could help prevent fraud and also “balance the overemphasis on the entrepreneur as the sole perpetrator of wrongdoing.”

But until the day when investors may be willing to shoulder some blame, it is important for founders not to succumb to the temptation of faking it until they make it.