Modern Entrepreneurial Fraud

Marc Penkala
5 min readJun 17, 2019

Startup Scams and Outright Frauds from Hegestratos to Elizabeth Holmes.

Book Cover “The Ionia Sanction

Well, fraud has been around since the dawn of commerce — not surprising at all, I guess.

300 B.C., a Greek merchant named Hegestratos and his Co-Founder Xenothemis started the very first InsureTech in ancient Babylonia, with more or less doubtful intentions. They used a form of maritime insurance, known as bottomry (the captain of a boat borrows money from a lender, sets sail and if the boat makes it to the next harbour, he has to pay back the lender what he borrowed plus interest. If the boat sinks on the way, the lender loses his money) to make a quick buck, or in their case a shiny Silver Drachma.

Though, sneaky Hegestratos and Xenothemis did not plan to go to the next harbour, instead they aimed to sink their empty boat, keep the loan and sell the corn. Too bad it didn't work, they drowned trying to escape the crew when they caught them in the act. This is actually the first recorded fraud incident we know of.

“Those who cannot remember the past are condemned to repeat it.” — George Santayana —

Winding forward a couple of years. Bernard L. Madoff. You know “Bernie”, right? If not, shame on you. The talented Mr. Madoff was probably a bit too inspired by the Italian born immigrant Charles Ponzi, the godfather of investment fraud or pyramid schemes — more commonly known as Ponzi Schemes.

In a nutshell, “Bernie” pulled off one of the most memorable and expensive financial fraud cases of all time, a financial swindle in which early investors are repaid with money acquired from later investors, rather than from actual investment income.

Prosecutors estimated the fraud to be worth USD 65 billion, effecting 3 million investors directly or indirectly. Bernie kept up to 45.000 lawyers busy, on December 11th, 2008, he was arrested and charged with securities fraud and sentence to 150 years in federal prison.

“Fraud is the daughter of greed.” — John Grant —

It’s not hard to imagine that fraud and scams are a part of the entrepreneurial ecosystem, as well. Not too many places are more receptive to breaking ideas and disruptive business models than Silicon Valley. An outstanding idea — especially if it’s presented by the right person — may essentially win a blank check to bring a vision to life.

Theranos the revolutionary blood test that never existed was one of the biggest startup frauds ever perpetuated. CEO Elizabeth Holmes falsified test results, misled partners, released incomplete devices and repeatedly denied accusations of wrongdoing. Well, aside of that Elizabeth Holmes managed to raise a whopping amount of USD 1.1 billion.

The (not so) Honest Company offers consumer healthy, natural alternatives to heavily processed household goods. Whatsoever, 2017 allegations were made that the company had engaged in fraudulent labeling of its products. Promotional materials claimed that all goods were free of synthetic chemicals. Though, independent tests have shown that all of them contained synthetic chemicals, some known to be toxic, as well. The founder Jessica Alba raised USD 490 million.

Hampton Creek, a vegan food manufacturer, was accused of falsifying sales data, after reports surfaced that they had instructed contractors to secretly buy back their own products from supermarkets across the United States creating the perception that the product was significantly more popular than it actually was. CEO Josh Tetrick raised USD 240 million.

Skully an augmented reality motorcycle helmet company, which never did see the light of day. Skully repeatedly pushed back the shipping date, blaming logistical difficulties and technical problems, while the founders lived the Great Gatsby life. They had spent most of the money on luxurious purchases, including rent on their apartment in San Francisco’s Marina District, two Dodge Viper, four motorcycles and entertainment at a gentlemen’s club — these cheeky fellows.

Mozido aimed to develop white-labeled financial products for two billion unbanked people around the world, who lack a traditional bank account. In 2018, the SEC claiming that the founder Michael Liberty defrauded 200 investors, from which he raised USD 55 million. Liberty was accused of using a number of shell companies to divert funds from investors to his personal accounts. The founder Michael Liberty raised USD 314 million.

“Our ability to manufacture fraud now exceeds our ability to detect it” — Al Pacino —

What exactly can we learn from all this? I think it’s not only about our gut feeling or experience, there are various other factors which make the sole difference.

The power of story telling, some entrepreneurs have mastered the art of storytelling, like Elizabeth Holmes. VCs really love great stories and big pictures, we are always seeking for the next homerun. Therefore, it is inevitable to dig deeper, ask the right, sometimes inconvenient questions — look behind the curtain of a story.

Big names, valuation and funding don’t always reflect a company’s actual accomplishments or potential. Don’t go with the flow, because you face the fear of missing out. Do your homework, without being prejudiced by others talking you into a deal — confirmation bias is a real thing

Opportunity makes a thief, be mindful about who you invest into, otherwise they might betray you, like the founders of Mozido or Skully. Startup culture, employee feedback and even employee pushback are necessary for business success — Do background checks.

Governance and investment controlling will help you along the way. It is crucial to detect inappropriate risk taking, fraudulent behaviour or doubtful business practices as early a s possible— checks and balances will do the trick.

Fake it until you make it, or rather until you become it. Overselling and some window dressing is ok, as long as you play by the rules. The relationship between VCs and founders is a sensible one, based on trust and modesty.

Any thoughts or questions? Reach out! Want read more?

The Angel Performance Playbook

Schrödinger’s Valuation Problem

Maximizing Fund Distributions

Cap Table Madness

Venture Capital Fund(amentals)

Equity, debt and the grey zone in-between

KPI <kē pərˈfôrməns ˈindiˌkātər> Hunter

About myself

I am a passionate and hands-on venture capitalist (+6y), entrepreneur (+7y), mentor and angel investor. After 6years of flying over 1.000.000 miles, spending 1.200 hours on airplanes, looking at 1.000 start-up pitches on all continents, I decided to gather some of my thoughts based on this extremely rewarding professional journey at Mountain Partners. Reach out!

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Marc Penkala

Venture Capitalist @ āltitude | creating better access, earlier.