The Ethics of VC — why being a VC (or tech) pirate seems to work less and less (#5)
We have seen an increasing amount of scandals in the tech world over the last few years. From Uber to Theranos to Facebook and Hampton Creek, many VC-backed start-up companies coming out of Silicon Valley have recently received bad press.
The issues that some of these tech companies were accused of range from blatant fraud (Theranos, uBeam, Mozido), sexual harassment (Uber, Betterworks), privacy breaches (Facebook) to product buybacks (Hampton Creek) and complaints regarding “toxic” company culture (e.g. sexism at Zenefits and Uber).
Mostly, it was the founders — Mark Zuckerberg, Elizabeth Holmes, Travis Kalanick — that were blamed. In the majority of these cases, they left (or had to leave) the company; in some cases they are still awaiting prosecution (and likely prison time in Holmes’ case).
Due to these incidents, some investors (such as Tim Draper, one of the Theranos funders) have been under pressure from both the public and/or their LPs (limited partners — investors into the VC funds) to conduct a more thorough due diligence exactly in the way that I have argued above and to be a more critical and involved board member.
As a result, they might face awkward questions the next time they raise a new fund. The same sort of scrutiny might hit some of the eminent persona on, for instance, the advisory board of Theranos: did Kissinger, Shultz and Mattis reallynot know anything? Some of these scandals escalated to the point where companies ridden with crime and wrongdoing decided to change their leadership (e.g.Uber,Zenefits), or, in some cases, shut down completely (a great overview from Forbeshere).
I want to take a moment to put this into a more structured context, sketching briefly the different kinds of forces and stakeholders — from the customers and the founders, to the regulators, the press and the LPs — that are at work making it less and less desirable to be identified as a ‘pirate investor’ (or tech company).
Commentators recently started calling it the ‘Greta effect’: the world is shifting to green. Sustainable fashion, less meat and dairy, electric mobility, (real) sharing economy services — new, better markets are growing heavily. But customers don’t only care about better consumption, they also care about bettercompanies. Uber lost hundreds of thousands of users in 2017 when allegations against Travis Kalanick first came up and cases of sexism in the company were reported; and the#deletecoinbase movement from earlier in 2019 caused enormous deletions as well mainly based on its shady user privacy policies and possible involvement with government surveillance (not to talk about Theranos and most recently Juul when their scandals first broke). This obviously has consequences for investors some of whom (most notably the late ones like Softbank) have lost hard cash, but also in terms of their reputation which is where the founders come in.
Founders care (and so do employees)
The NYT earlier this year reported on a large group of startup founders being much more critical about who they take money from. Some of them were part of an organisation called Founders of Change which has since grown to more than 1000 founders who campaign for instance for more diversity (both within their companies and investors). Many of these founders explicitly state that they would refuse money from VCs who don’t adhere to their principles. More generally, it seems like a rational step to — as a (Gen-Y) founder — be weary of one of the investors in a ‘scandalous’ company in an environment where many founders can choose whom to take money from (not to mention employees becoming more and more picky). And for the VCs, having access to a large diversity of startups — given the small percentage of success — is the most critical currency. Being excluded from deals is the biggest threat for a VC — and the biggest existential risk.
Facial recognition is starting to be heavily regulated (in EU and US) and so is vaping (two investor darlings until recently). Obviously there is the far-reaching privacy regulation GDPR (currently being rolled out into some US states) as well as first attempts to protect labour in the gig economy (notably in California). And then there are the fines: Google (several billion in anti-trust fines), Facebook($5bn for its Cambridge Analytica breach), Apple ($15bn for tax evasion). We don’t need to get into the talk about breaking up big tech (which the EU commissioner Vestager — contrary to common fears — doesn’t support anyway), but withdrawing operating licenses (e.g. Uber in London) or not even granting them for new business models (e.g. Facebook’s digital currency Libra) is a real regulatory threat. Overall, we can see that there is a real clamp down on the big tech companies that already has trickle-down effects on many others (privacy is obviously an issue for any B2C company). All of this is already heavily influencing tech revenue models and practices; and I expect it will even more heavily move the next generation of founders and hence the next round of VC opportunities.
The press cares
And all of this is exaggerated by a press that seems increasingly shifting away from promoting shareholder capitalism. Take the recent re-branding of the Financial Times. Capitalism. Time for a Reset.The supposedly most business minded newspaper has decided to focus on ‘promoting stronger corporate purpose’. Additionally, US editor Gilian Tett (another anthropologist) has earlier this year launched a new site called Moral Money focused on socially responsible business. Last month’s Fast Company cover announced in a very similar fashion a re-vamping of capitalism featuring big reports on Patagonia (one of the big promoters of the sustainable corporation), the Ford Foundation and how to rethink (or do away with) philanthropy. Obviously, it was also reporters from the WSJ and the NYT who broke and aggravated the big stories on Theranos and Uber’ssexism issue (in both cases based on whistle-blower accounts). For reports, there is increased attention on promoting doing goodwhich also comes with increased scrutiny on tech companies and investors to avoid doing bad.
And lastly: LPs are starting to care, too
Son at Softbank — surely an outlier, but also a signpost — has already found himself struggling terribly with raising his new fund in recent weeks (mainly based on the reported losses with WeWork, Uber and Co). LPs don’t like losses and can at times be rather quick to drop a fund. LPs — and groups of them such as the 30% Club– are also starting to push down on softer issues, such as gender diversity and inclusion (at least partly because that also makes sense financially). And in fact, in the neighbouring private equity industry, LPs are already much more strictly enforcing for instance ESG guidelines in their GPs — they want to invest in ‘good corporate citizens’ and not pirate investors. When is this going to swap over into the VC world (where many of the same LPs are active)?
So, yes, LPs ultimately mostly care about their bottom line. But it seems less and less likely that venture profit can remain independent of ‘ethics’ — given the increasing pressure from the different stakeholders above. As the influence of these stakeholders grows, we might see that the first bottom line — returns — and the second — doing good — become more and more aligned.