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two fish on a beg of ice

The Potential For Divesting In Startups

Earlier this year, we discovered that Tinder is/was seemingly run by terrible men.  Ditto Snapchat.  And it prompted a conversation with a friend about moral hazards, modern tech investing, and the increasing problem that the current investment environment is bringing to light.

Basically, to paraphrase the conversation, imagine you were a VC who was approached by Tinder early on (yes, I know, they haven’t raised 3rd party money but that’s why this is a hypothetical question).  Because you’re a smart VC, you do your due diligence and spend enough time with the founding team to recognize that they have some rather serious problems, most prominent being that they don’t understand that sexual harassment is against the law.  But their app has promise and is gaining early traction.  What do you do?

First, let’s review the basic outcomes of all deals: investing/not investing and going big/going bust.  If you invest and they don’t go big, it is at worst a C-: VCs have to eventually invest in winners but they’re expected to back some losers along the way.  Don’t invest and they go big, you get some social ribbing for having missed the boat but probably don’t get fired; C- at worst.  Don’t invest and they bust, you don’t really get credit for having dodged a bullet because most things bust anyway, but we’ll give you a straight B anyway.

The problem is in the invest/go big condition.  If you invest and they go big, you are rewarded professionally, personally, financially, and socially: A+ doesn’t even begin to describe it.  Picking a winner is like winning the lottery, except instead of just a one-time payout, you get the gift that keeps on giving.  Other hot startups now want you in their deals.  You can leave and become an angel or even a super angel, or stay at your firm and ride that big win.  Or retire.

And when the companies are good and do good things, that isn’t terrible.  We can make an “absolute power corrupts absolutely” argument but that isn’t so much the Tinder dilemma.  The problem with Tinder is that you know that by investing, you are putting money in the hands of people who clearly aren’t ready to handle it.  You’ve seen them in action and you know that eventually these clowns will be sued and settle for an undisclosed amount of money because writing threatening texts and calling an employee a whore in meetings is more important to them than getting work done.

That is a real financial considerations: if the suit happens too early, before other people put in money and they gain traction, then the company will fold and you will lose your money.  But the mild ding you get for backing a failed company is going to be just that: mild.  You won’t be hounded by the press for investing in sexual harassers and nobody at your firm is going to caution you against the dangers of giving money to criminals – the biggest problem is the lost investment, not the reason it got lost.

And if you win, like Tinder has, then nobody is going to blame you for doing it in a morally bankrupt way.  Because Tinder has a valuation of $1B, early investors would be getting all of the glory without paying any of the costs.  I have yet to see an article calling out IAC for backing the folks that threatened to fire a female employee because of who she was dating and I’m not expecting to see it happen anytime soon.

And therein lies the issue.  Because we expect VCs to invest only based on financial returns, then the people with the most insight into the actual founding team of a company are the ones who are explicitly commanded not to pay attention whether investing in them is moral or not.  In the case of both Snapchat and Tinder, it is impossible to reasonably argue that the CEOs have acted with sound moral judgment.  And yet there is a sense in which it doesn’t matter.  Users, if they know, are unlikely to stop using the service in sufficient numbers to cause a ripple effect that would hurt the bottom line.  And even if they do, it is only the failure itself that matters, not the reason for it: you undergo no additional penalty as a VC for having backed the morally bankrupt.

This is a profoundly bizarre state of affairs.  Time and time again, very smart VCs write about how important founding teams are and how they are really investing in people and their ability to execute, rather than the quality of the idea itself.  So how is it that when a company fails because of the moral turpitude of their founders, we don’t hold both founders and VCs to task?  After all, if the sole job of VCs is to evaluate quality of a team, shouldn’t they be held accountable for bad teams?

One might argue that there is no way a VC could have known that Justin Mateen and Sean Rad would sexually harass Whitney Wolfe.  But I call bullshit.  If you’re investing in something, you’re spending enough time in the office to see the tone and tenor and you’re a part of that tone and tenor yourself.  If you’re not creating an environment where Wolfe can come to you with her concerns, you are failing as an investor and should have been named as an additional party in her lawsuit.

But that’s not the current state of affairs.  As long as VCs are known only for their financial wins and not the manner in which those wins occur, and those who pass for good moral reasons are not rewarded with social applause and professional accommodation, then it will continue to be irrelevant if startup founders behave in despicable ways.  Unless the penalty is that no one will invest in their success, there will be no reason to quit.

Side note: how ridiculous it is that Sean Rad thinks that the important issue with Wolfe is whether or not she is called a cofounder, not the fact that she was absolutely sexually harassed in a public and amazingly awful way within the company?  Also, don’t say that Justin Matten was and continues to be your best friend and that he voluntarily resigned.  Read the texts.