As more apparently successful companies stayed private for longer, investors’ fear of missing out on the next Amazon or Google grew. That left them vulnerable to hucksters. Investors started picking companies based on who else was part of the funding round rather than on whether the entrepreneur’s business plan made sense.
The longer interest rates stayed low, the worse the problem became as institutional investors allocated more and more money to private investment funds.
Flush with heaps of “dry powder”, big players such as SoftBank, Tiger Global and Sequoia boasted of the speed at which they could deploy capital. That put pressure on rivals to call off their lawyers and accountants. Many agreed to invest with little or no protection for their money. Bankman-Fried refused to put investor representatives on the FTX board and used two little known auditing firms.
Even when investors did insist on doing diligence, the hands-on work usually fell to the youngest lawyers, consultants and bankers. Today’s 20-somethings have no meaningful downturn experience so were less experienced at judging the adequacy of controls and clauses that only matter when money starts to run out.
And run out it has. Venture capital funding in the third quarter dropped 53 per cent year on year, according to Crunchbase. With interest rates and bond yields rising, investors no longer have to take wild bets to get a decent return. Volatile markets have reminded us that the valuations don’t always go up, even for winners: Google and Amazon share prices are down by more than one-third since January.
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