I estimate that 1-2% of $100M+ YCombinator-backed companies have faced serious allegations of fraud.
- I’m interested in better understanding the base rates of fraud in high-growth companies. YCombinator is a convenience sample for “high-growth companies”, as they are relatively public about who they back, and act as a filter for e.g. “obviously fraudulent” companies.
- I was able to find 3 companies which closed due to (alleged) fraud, two more which had their business substantially impacted by fraud claims, and three which had mild business impacts from fraud claims.
- YCombinator has incubated 3,951 companies, which gives a naïve rate of ~0.1% of companies having major allegations of fraud.
- I estimate that there are around 400 YCombinator-incubated companies with a valuation over $100M. 3 of the 5 companies with major fraud had $100M+ valuations, implying that 3/400 = 1% of $100M+ companies have major fraud charges. I think that this 1% number is probably more useful than the previous 0.1% number, because I expect that many smaller companies were fraudulent but no one bothered to charge them or report on it.
- I also wouldn’t be surprised to learn if I missed some cases, though I’d be surprised if I missed more than half of the $100M+ cases.
- So overall, I estimate that maybe 1-2% of $100M+ YCombinator-backed companies have faced serious charges of fraud.
- It’s notable that almost half of the companies on this list are financial services, which I believe makes them overrepresented.
- I expect that YCombinator is better at filtering out fraudulent companies than other angel investors, but they are also more likely to generate highly valuable companies. I’m not sure how these factors balance out, but would guess that they are roughly equal, implying that 1-2% of all high-growth $100M+ companies face serious fraud charges.
|uBiome||$298M||Fatal||“the company shut down in 2019 following an investigation into possible insurance fraud… Since 2021, the FBI has considered [the founders] to be fugitives.” (Wikipedia)|
|LendUp||$500M||Fatal||"We are shuttering the lending operations of this fintech for repeatedly lying and illegally cheating its customers," said CFPB Director Rohit Chopra. (Reuters)|
|Stablegains||$6-15M||Fatal||Invested customer funds into a cryptocurrency which collapsed. Customers allege this was deceptive, though I can’t find any evidence of them actually being charged (yet). (The Defiant)|
|Synapsica||$8-20M||Major||Two cofounders charged with defrauding the third and other investors. 1/3 of employees were laid off, which the company claims is unrelated to the fraud charges.|
|Flutterwave||$3B||Major||Assets frozen over claimed violations of anti-money laundering laws. The company denies misconduct and seems to still be operating at a large scale. I am unfamiliar with the Nigerian legal/financial system, and it’s unclear to me how serious these charges are.|
|Zenefits||$4.5B||Major||CEO resigned over accusations of violating licensing laws. Went through several rounds of layoffs; unclear how related to these accusations those are. (Ben Kuhn)|
|Bikayi||$21-50M||Mild||Salespeople forged signatures of customers. It looks to me like the company separately encountered financial trouble and this fraud in particular was maybe just used as a cover to fire people.|
|Momentus||$65M||Mild||SEC settled charges that the CEO misled investors about his immigration status and the results of a test of their technology during an attempt to take the company public. The company has now successfully gone public; my impression is that the CEO was fired but otherwise the company is fine.|
|Modern Health||$1.2B||Mild||One cofounder sued the other for defrauding investors by not disclosing incentives provided to customers which may have boosted sales. It seems like few media venues have picked up on the story, and so far the impact on their business seems mild.|
|Dreamworld||$1.8M||Not actual fraud?||“The main accusation is that DreamWorld is a scam: an impossible project helmed by two people who have no idea what they're doing.” (PC Gamer) It looks to me like this is just a bad product, rather than fraud per se.|
|Thrive Agric||$112-282M||Not actual fraud?||Accused of being a Ponzi scheme after missing payments to investors. It looks like those payments have now been made and I can’t find any outstanding accusations.|
I would like to thank Oli Habryka for pointing me to about half of these examples.
Addendum: Founder Fraud
I additionally came across 2 founders of YCombinator-backed companies who were charged with fraud unrelated to their business:
- Aaron Swartz
- Cofounder of Reddit
- Charged with wire fraud for breaking the copyright on academic papers
- Ilya Lichtenstein
In this list YCombinator publishes of their most valuable companies, the one closest to the bottom that I can find a public valuation estimate for is Fampay, ranked #311, with a valuation of $150-170M. I think the difference in valuation between companies at the bottom of this list is relatively small, for example Drchrono (#269) was acquired for $180M. Additionally, there are 13 publicly traded YCombinator companies with a market capitalization above $100 million. So I’m going to guess that there are around 400 companies with a $100M+ valuation, but I’m not sure.
I can’t find information about their valuation, but they raised $3 million at their most recent round and I would expect that this was in exchange for a 20-50% stake
Using the same 20-50% heuristic as with Stablegains, applied to their $4.2 million series A
Same heuristic, applied to their $10.8 million series A
They have not raised outside the initial YCombinator investment, which generally values companies at $1.8 million
Standard heuristic, applied to their $56.4 million series A
I’m probably being daft.. but what does this have to do with effective altruism?
My thought was: base rates for FTX-style disasters?
Got it. FTX wasn't Y-combinator incubated right? (A quick google doesn't seem to suggest it was). Not that that nullifies your point - I'm just clarifying
That's correct. YCombinator is a convenience sample for rapid-growth companies. I would find it helpful of people repeated this for other samples; the next one on my mind currently is Sequoia-backed companies.
It’s interesting to me, because many entrepreneurs like myself get into entrepreneurship with (we sincerely believe) a goal of making the world a better place. Some are seemingly frauds. It is good to read this, to gain perspective on what not to do.
I think it's worth noting that fraud can be a grey thing. Which of the following are fraud:
A) Two founders raise $2M at a $20M valuation. They pay themselves $500k each for two years (a bit higher than their previous FAANG salaries), don't work that hard, write a bit of code but not enough for the product. They ultimately try to raise more but fail to do so and dissolve the company giving investors nothing back (all the money is spent).
B) Companies collect credit card details on a 7 day free trial of their product where only shipping needs to be paid. Immediately after 7 days, they charge the credit cards $1000 and send product saying that in the fine print they had to cancel within 7 days or they would be sent the product. The customers would never pay for the product, comparable products cost $100 for what was sent and the company refuses to provide any refund. They spent a lot on the advertisement and got 5000 people to take the 7-day free trial, 4500 of whom did not cancel.
C) Medical startup administers more tests than is necessary charging health insurance providers (Medicare and private insurance). Rarely a test finds something that otherwise would have been missed but was definitely not required given symptoms.
D) Company X raises $500k at a $5M valuation. They spend $250k reasonably on product development. They then need $500k for a mold for manufacturing. They look for financing in the form of bridge loans, raising additional capital, going back to investors telling them they need another $250k, etc. and don't manage to do so. CEO of Company X decides that this mold is pivotal for the company and is a good poker player.
i) He takes the $250k to the poker table and doubles the money.
ii) He loses $150k and then decides to save the other $100k
iii) He loses the $250k
E) Company X raises a seed round and builds an MVP. They then go on to raise a series A, showing investors a beautiful exponential curve of new users. The company allows the first use of an account to be for free and subsequent use costs $5. Founders purposely make signing up for new accounts very easy such that they know multiple people are making several accounts to use the product for free.
F) Company X gets funded by YC and takes the $125k and $375k cheques for 7% and the MFN safe. They never intend to raise another round since they are already profitable but they need to in order to satisfy the MFN clause. They get a family friend to invest $100k at a $1B valuation forcing YC to take those terms. Maybe they later buy out the friend for $105k a few months later.
I don't know which of the above legally qualifies as fraud but I sure think all of them are at the very least wrong. I'd probably call all of them fraud since they are deliberately deceiving people for financial gain by being credited with false accomplishments/qualities. I also think reasonable people can disagree with me.
If a VC isn't investing in some frauds they're being overly conservative IMO given the extreme power laws that govern the returns to VC investing. Of course you need to do some due diligence, but ultimately it's going to be way too much time and effort to flush out every potential fraudster that wants your money, and you only have so much time to find good investment opportunities.
Obviously that piece on Sequioa's website about how amazing SBF is looks terrible in hindsight, but I thought a lot of the commentary surrounding it betrayed a fundamental misunderstanding of how early-stage investing actually works vs late-stage investing. Perhaps fair enough to criticize the people who invested in FTX in late 2021 or 2022 (they did their Series C only in Jan 2022!), but even then it's probably not always easy to distinguish between a hypergrowth company & an unsustainable fraud from the outside. And ofc SBF had told a lot of lies to everyone, his investors included. The better argument might be that any VC that touches crypto is an idiot because the whole space is ultimately going to zero (I don't actually believe that but it's not far off, certainly most currrent projects will fail including BTC), but then again, through token sales crypto offers amazing ways for VCs to make money even on failed investments.
Ultimately VC is just very different to most other forms of investing, including investing the reputational capital of your movement on a high-profile billionaire. Then you really should do some DD.
This. We forgot that our movement runs on reputation, and reputation is easy to lose, and hard to gain (And rightly so.)
Don't forget Zenefits!
Zenefits was valued at $4.5b in 2015 and was all downhill after the incident; they did three rounds of layoffs in four years and were eventually acquired by a no-name company for an undisclosed price in 2022. It's unclear how much of that decline was directly a result of the fraud, vs. the founder's departure, vs. them always having had poor fundamentals and being overvalued at $4.5b due to hype.
Thanks! I don't really understand if this technically qualifies as fraud, but seems spiritually similar – I added it to the table and cited you.
The Aaron Swartz thing is not really the same kind of thing as the others, on various levels. See: https://en.wikipedia.org/wiki/United_States_v._Swartz
Off-topic but I thought the 'Company', 'Valuation' and 'Severity' columns were too narrow. They're hard to read on mobile.
Thanks! How does it look now?
Looks good, thanks!