When FTX's CEO pocketed the lion's share of a $420.69 million venture round last October, VC investors were so eager to get a piece of the action that they didn't look at the books.
Why would you be surprised when a guy who held a fundraising round of exactly $420.69 million turned out not to be a serious, responsible corporate executive?
That marijuana-and-oral-sex referencing raise, which the now former CEO of bankrupt crypto exchange FTX Sam Bankman-Fried closed in October 2021, should have been a red flag.
After all, the Wall Street Journal has reported Bankman-Fried used the venture funds to cash out $300 million, describing it as repayment of part of the $2.1 billion he spent buying out Binance's roughly 15% stake in his exchange.
A large chunk of that payment — $529 million worth just before FTX went belly-up — was in the FTX-issued exchange token FTT. That would later bring down Bankman-Fried's house of cards when CoinDesk revealed just how much of it the exchange had on its books, and when Binance CEO Changpeng "CZ" Zhao announced he was going to sell it.
That was because it was collateral for the $10 billion worth of FTX customer funds he secretly loaned his trading firm Alameda Research after it lost heavily during crypto winter and the $48 billion collapse of the Terra/LUNA stablecoin. When FTT tanked and customers began a run on FTX, fearing — accurately — it could not meet withdrawal demands, about $8 billion was found to be missing.
"Seems" because just like Bankman-Fried's $300 million cash-out, the record keeping of FTX Group — which includes those two companies, the American exchange FTX US, and about 130 other smaller companies — was so poor, lacking and missing that the new leadership brought in to restructure the companies in bankruptcy don't know what its assets are. This series of events led to the popularity of proof-of-reserves.
Show Me the Money!
Which is why venture capital firms traditionally want to look at the books before investing — and why they usually want to crawl deep down a company's throat when a top executive is looking to cash out a large chunk of equity.
Generally speaking, investors want to get rich before the CEO they are backing does. It keeps them focused.
But, as VC firms scrambled to get pieces of start-up pie as the past decade's economic boom took off, many — especially in the crypto industry where huge fortunes could be made when new tokens "mooned" — cut their standards, the WSJ said. And Bankman-Fried was known for a take-it-or-leave-it approach to investors.
Which was something he could get away with after having built the world's second-largest crypto exchange from scratch in just three years.
"Anytime you see a founder selling shares in a secondary offering, you have to really ask them pretty tough questions," Charles Elson, a University of Delaware professor who studies corporate governance, told the WSJ.
The problem, he said, is that it suggests the founder thinks there are better investments to be had.
However, the new FTX CEO, restructuring expert John Ray III has a bigger problem: he has to figure out what happened to that $300 million.
