The Institutional Investors Who Lost With FTX

A few people in the comments sections of my
recent videos about the whole situation at FTX are acting like these videos are designed
to be funny, or that they are comedy of some sort, and that is just not true, and it is
a mischaracterization of my YouTube channel and what I’m trying to do here. Today I’m going to be talking about the
venture capital firms that invested in FTX, and so to a certain extent I have to rely
on one of the documents from Sequoia (one of the big Tech VC firms) websites (that they
have since deleted.) This document explains the thought process
around their investment, which they were clearly very proud of only a few weeks ago. Now look, there is stuff in there like the
bit when SBF pitched to the partners that his vision for FTX was of a super app.

“You can buy a banana, you can do anything
you want with your money” Sam allegedly said to them while dressed like an unruly
toddler and playing video games. But, that’s not a joke (it is just what
happened – It’s in the document – and it was deemed relevant by the partners at
Sequoia as otherwise they wouldn’t have publicized it on their website), and we are
not really going to learn much about Technology Venture Capital investing here, if people
are just going to snicker about things like this in the comments section of my videos.

In California, particularly in Silicon Valley,
online cryptocurrency trading and banana procurement are the kind of problems that still need to
be solved, and to many in the Venture Capital space, Sam Bankman Fried looked like the man
who would solve that problem. This banana statement from Sam apparently
blew the partners away. The document goes on to explain that what
Sequoia was reacting to – wasn’t just the idea of getting a banana – it was the
scale of SBF’s vision. This wasn’t a story about how we might use
fintech in the future, or crypto, or a new kind of bank. It was a vision about the future of money
itself—with a total addressable market of every person on the entire planet.

That is what they say… And, that really is the thing, a crypto brokerage
might have a market that is capped at a certain size (there are only so many people interested
in trading cryptocurrencies and wealthy enough to trade cryptocurrencies), but almost everyone
on the planet would consider eating a banana. And it’s not just people either, monkeys
love bananas, and for all we know maybe a monkey would happily give you a bitcoin which
is worth around $16 thousand dollars for a banana, as monkeys have no use for bitcoins,
and they love bananas. Sam was singing the VC investors a song they
wanted to hear, and he was doing it while playing video games. I think we can all agree that – in truth
– the partners had the wool pulled over their eyes by Sam, who at no point appears to have
transacted in bananas after taking their investment and we don’t yet know if any monkeys have
found themselves facing financial hardship after opening accounts at FTX. The press just aren’t talking about that.

So anyhow, like I said… this is a serious
video, and if you think it is funny you just don’t understand how things work in Silicon
Valley, and that is your fault, not mine. I have been doing my best to explain it. Now, before we go any further let me tell
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Click the link in the description to start
your 7-day free trial and get 25% off a premium membership. OK, so, according to Sam, what happened next
at FTX was a simple 8-billion-dollar mistake. There has been no real explanation as to what
exactly happened with the customer funds that have gone missing. The closest thing to an explanation that we
have is a tweet from Sam saying that the issue stemmed from a poor internal labeling of bank
related accounts. Now of course if that was the case, I would
imagine that some quick re labeling could have occurred, and then everything would have
been fine, but a relabeling solution is starting to look less and less likely right now as
many of the FTX employees have reportedly fled the Bahamas, some even abandoning their
cars at the airport.

That is the thing with “Gen Z”, a bit
of labeling work turns up, and suddenly there is no one to be found. But anyhow… Now, of course, while people do make 8-billion-dollar
mistakes all the time… It is likely that we are instead looking at
a huge fraud. The bankruptcy filings state that the company’s
management used software to conceal the misuse of customer funds. That, on it’s own is fairly damning. While it is totally reasonable for Sam to
have lost his own money, and the money of the VC investors, there is no reason that
customer funds were ever touched. Sam appears to have invested in Robinhood
and in Twitter, money was spent on sponsorships and given to politicians. Money was invested into the very VC funds
that invested in FTX.

Shouldn’t the venture capital funds have
considered it a bit strange that Sam had enough money to invest with them, but was asking
them to invest in his firm? $300 million dollars worth of real estate
was bought by FTX which was used as homes and vacation properties for FTX executives. Sam’s parents – two college professors
bought property in the Bahamas worth 121 million dollars. On top of all of this Sam bought a Toyota
Corolla to demonstrate how humble he is. So, which venture capital firms invested in
FTX and why? Well, Tiger Global- as an example, was an
early investor. They first invested in FTX in a Series A round
in 2019, which raised $8 million. Tiger would later go on to invest in two more
rounds. Others in the Series A included Lightspeed
Venture Partners, Temasek, and Binance Labs. Oh yeah and of course there was Softbank too… After raising 8 million in 2019, the pandemic
struck in 2020 and people stayed at home and traded cryptocurrencies, by July 2021, in
a much hotter market, FTX was able to raise a billion dollars, with additional brand name
investors including Third Point Ventures, Coinbase Ventures, and Thoma Bravo.

Orlando Bravo – the founder – had been a
student of Sam’s fathers at Stanford, and was excited to invest with his professors
son. In October 2021, FTX raised a meme round of
$420 million dollars from 69 investors (both of those numbers are considered lucky in Silicon
Valley). This capital raise valued the firm at $24.5
billion. Tiger Global was in that round, as was Lightspeed,
Temasek, and Senator Investment Group — along with dozens of others. It wasn’t just sophisticated investors who
put their money in either, Kevin O’Leary invested too. The most recent fundraising round occurred
in January of this year, as crypto had already begun it’s fall. The $500 million Series C, which valued FTX
at $32.5 billion, included investors like SoftBank, Lux Capital, Tiger Global, Lightspeed,
and Temasek, among others.

Now that FTX has filed for bankruptcy, these
investments appear to be entirely gone. Many of the investors have marked their holdings
in the company to zero. These investors will be stuck facing tough
questions from their investors about how they missed all of the red flags. They’ll have to explain why they didn’t
demand board seats, and what exactly their analysis involved. Over the last year we have seen that it is
not just retail investors who experience FOMO.

The Financial times interviewed a few VC investors,
who didn’t give their names. One claimed to have been “seduced,” He
said that with hindsight, he thinks that when his firm questioned SBF before investing,
they should have focused more on the details about the crypto exchange’s governance and
financial controls — rather than being blinded by its founder’s snowballing celebrity profile. He went on to say that he had some reservations
during initial calls with SBF, including the way Sam “comported himself” and the sense
that Sam believed everyone else in the financial world “were idiots”.

Another venture capitalist said that due diligence
did not reveal the high levels of leverage in the business — he claimed that investors
were only shown the balance sheet at quarter end and the leverage was not on it. It is normal for VC investors to ask for a
seat on a portfolio company’s board, in order to monitor their investment and have
some control, but at FTX, none of the investors had board representation. The three-person board of FTX consisted of
Sam Bankman-Fried; Jonathan Cheesman, a former FTX executive; and Arthur Thomas, a lawyer
in Antigua who specializes in online gaming. With startup investments, VC firms are often
most worried about a product failing.

They give a founder a lot of money to build
out a business, and the risk is that the founder either builds a product that doesn’t work
or that there is no market for. VC’s are used to dealing with businesses
that might have sloppy accounting and bad governance, as that is often the nature of
investing in startups, but often the VC firm brings this type of professionalism to the
table. They put their own people on the board and
get financial reporting “in order” in time for the company to go public.

Tiger Global, who I mentioned was one of the
first investors in FTX had a reputation for being a founder friendly investor who moved
fast and did less due diligence than other investors – they reportedly closed one new
investment per day last year! Tiger hired the consulting company Bain & Co.
to do due diligence on FTX. In fact, Bloomberg reports that Tiger pays
Bain more than $100 million a year to do research like this for them.

According to a number of investors Sam Bankman-Fried’s
pitch to investors was not much of a pitch: It was a take-it-or-leave-it offer. The New York Times reports that the pitch
was – that FTX was Sam’s company, and he planned to run it with little oversight and
interested investors should “support him and observe.” One investor apparently asked Sam to put together
a presentation. The presentation was allegedly thrown together
in PowerPoint in a few hours. “There was no formatting, the fonts were
all mixed up. The story goes that the investors were a bit
uncomfortable that so little effort had been put in to explaining the business, but they
invested anyhow. Andreessen Horowitz one of the big VC firms
did pass on investing in FTX in part because its partners didn’t trust Sam. Elon Musk claimed that he turned down an investment
in Twitter from Sam as he had an instinct that something was wrong about him. Based on statements in the bankruptcy filing,
it now appears that this may be untrue and that Sam owns a $100 million dollar stake
in Twitter.

For years VC investors have been reducing
their standards and stripping away requirements that give them control over a company and
protect their investment. This is what they say they have to do to get
into the hottest deals. There is an argument that you might not be
making the best investments in such situations. We have in recent years seen venture capital
firms get excited about investing in firms like We Work – where they somehow got confused
that a coworking space with a beer tap was a technology startup. Last year’s investment manias in cryptocurrencies,
tech stocks and the SPAC boom only intensified this trend. Venture Capital Investors viewed FTX as a
way to dip a toe into cryptocurrency without buying risky coins or tokens. The idea being to invest in the casino rather
than gamble at the tables. They often viewed FTX as a safer bet than
Binance, since FTX had pushed to establish some sort of regulatory regime in Washington
while Binance had drawn controversy by dodging financial regulations around the world. So how bad is the performance at these funds? Well, it is difficult to say, as a lot depends
on their overall portfolios.

They will have invested in all sorts of other
startup firms that are difficult to value. It is probably a good guess that they are
not doing that well, as public tech stocks and unprofitable companies have not been having
a great 2022, so it’s reasonable to assume that their overall portfolios might be correlated
to an index like the Goldman Sachs Non- Profitable Tech Index. But it is important to realize that they won’t
be wiped out by their losses in FTX. Venture Capital is actually designed to take
big risks that often fail. Sequoia, an early backer of Google, PayPal
and WhatsApp, had $210mn invested in FTX, they went on to become Sam Bankman-Fried’s
biggest cheerleader. That position made up less than 3% of just
one of their funds. Other VC funds will have had similarly low
allocations to FTX.

So, while you might read about them losing
large dollar amounts, and being victims of this fraud, the loss is usually a small percentage
of their overall portfolios. One issue is that these high-profile investors
gave a certain respectability to FTX, a respectability that it didn’t deserve based on the way
it was being run and the lack of supervision by these name brand investors. FTX customers are likely to have lost significantly
higher percentages of their wealth when the firm collapsed two weeks ago than the venture
capital funds did. FTX marketed to retail investors that they
should have their pay checks deposited directly into their FTX account. This would have been a disaster to anyone
who followed that advice.

Because of the collapse of FTX, there is still
no super app where “You can buy a banana and you can do anything you want with your
money.” Who knows what wonders the future might bring. If you have a great idea for an app like that,
do let me know about it in the comments section, and I don’t want anyone making jokes down
there this week. If you enjoyed this video, you should watch
my video on blitzscaling next, which looks at how startups like Uber and WeWork can set
VC money on fire while trying to grow. Don’t forget to check out Blinkist our video
sponsor using the link in the description below. Have a great week and talk to you again soon,

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