A recent study from Imperial College in the U.K. and Emlyon Business School in France has outlined the methods by which Silicon Valley’s venture capital-backed entrepreneurs engage in fraudulent activities — and the influence of investors in these scenarios.

For this report, released online in June, researchers created a database of tech entrepreneurs and firms that encountered civil and criminal securities fraud actions from the SEC and DOJ from 2000 to 2023. 

Notable instances of tech entrepreneurs being found guilty of fraud in recent years include Frank’s Charlie Javice, Kalder’s Gökçe Güven, Terraform Labs’ Do Kwon, and GameOn’s Alexander and Valerie Lau Beckman.

Across X, the preferred social network for the tech sector, discussions surrounding fraud and its milder term “scam” are prevalent, as individuals ponder the boundaries of ambition and success. “Fraud is much more prevalent and accepted in the startup scene than we care to acknowledge,” Tim Weiss, one of the report’s authors, informed TechCrunch.

He referenced another study from the University of Toronto (UT), also published in June, which examined 654 fraud incidents involving U.S. venture-capital-backed startups from 2000 to 2023. It revealed that while fraud is generally rare, companies with venture backing were more susceptible to fraud accusations compared to those without venture funding. Furthermore, it indicated that startups established during overheated markets with inadequate oversight and investor diligence are 19% more prone to committing fraud later on. 

“The issue here is not solely with the founders, but also with those who establish and reinforce sometimes unrealistic expectations for rapid growth,” Weiss stated. He noted that the current exuberant AI startup landscape creates the ideal environment for founders to engage in fraudulent behavior.

The paper authored by Weiss, alongside Emlyon researcher Nevena Radoynovska, addresses the potential outcomes when founders encounter a discrepancy between investor expectations for their startups and actual performance. They might resort to “façading,” as termed in the paper, occurring in three progressively dishonest stages: surface, reinforced, and deep. 

Surface façading occurs when founders misrepresent the success level of their companies. This often takes place in the early stages when seeking investment by pitching a vision. It constitutes a greater degree of deceit than merely presenting an aspirational vision or an exaggerated total addressable market.

Following the surface façade, the founder may progress to “reinforced façading,” as outlined in the paper, which involves producing false evidence to support their earlier deceptions.

The paper provided an example of a mobile testing application that fabricated customer contracts and invoices, inflated reported revenue, and utilized these false documents to persuade VCs to fund it at a unicorn valuation.

From that point forward, founders may enter “deep façading,” wherein they amplify their deceptions to include areas such as exaggerating their technology’s capabilities, complete with manipulated demonstrations. This involves creating entire “parallel realities” based on falsehoods, according to Weiss.

However, investors are not always innocent parties, as the researchers discovered. Aside from the excessive growth expectations that drive founders toward fraud initially, some investors inadvertently “co-create fraud,” Weiss noted, by continuing to support founders—often the same individuals—who have been previously accused of fraud, thereby somewhat normalizing the behavior.

In fact, the UT study found limited evidence suggesting that allegations of fraud hinder founders from securing funding for new ventures, even when those fraud incidents garnered significant media coverage. 

“New investors and the broader VC landscape do not penalize historical misconduct,” the UT study stated, which is “also in line with the Silicon Valley ethos that accepts failure irrespective of its origins.”  

The research also indicated that startups with founder-controlled boards were twice as likely to commit fraud compared to those with boards controlled by investors or shared control. 

Even more notably, it observed that after VC-backed startups become public, they are more likely to confront securities class-action lawsuits within two years in comparison to public companies backed by private equity.

The prolonged duration companies remain private also plays a role in this issue. Public entities face more scrutiny than their private counterparts. “Founders lack a professional organization or association to govern or enforce standards of entrepreneurial and investor conduct regarding being effective founders and maintaining reasonable growth expectations,” Weiss remarked. 

Weiss advocates for the SEC to routinely conduct investigations and formal audits on startups once they surpass a significant “investment threshold.” Currently, the SEC typically waits for events like a whistleblower complaint or a lawsuit from investors or former employees to initiate an investigation.

Weiss’ paper further suggests that investors should bear more responsibility when urging founders to achieve extreme growth metrics.

“Investors should be held accountable for failures in corporate governance and breaches of their fiduciary responsibilities,” he asserted. He calls for more research into “entrepreneur-investor interactions” that could help mitigate fraud and also “balance the disproportionate focus on the entrepreneur as the lone instigator of wrongdoing.”

Fraud is seldom a singular act, in other words, and until investors are held responsible for the pressure they exert, founders will likely continue to be tempted to fake it until they make it.

This piece was updated.