Venture funding raises startup fraud risk, two studies find

A new report from the U.K.’s Imperial College and France’s Emlyon Business School has mapped how Silicon Valley’s venture-backed founders commit fraud, and the role investors play in enabling it. For the report, published online in June, researchers built a database of tech founders and companies that faced civil and criminal securities fraud prosecutions from the SEC (the US securities regulator) and DOJ (the US Justice Department) between 2000 and 2023. Recent cases of tech founders convicted of fraud include Frank’s Charlie Javice, Kalder’s Gökçe Güven, Terraform Labs’ Do Kwon, and GameOn’s Alexander and Valerie Lau Beckman.

“Fraud is much more common and normalized in the startup world than we are ready to admit and accept,” said Tim Weiss, one of the report’s authors. He pointed to a separate report from the University of Toronto, also published in June, that examined 654 fraud cases against U.S. venture-backed startups from 2000 to 2023. That report found fraud is rare overall, but that venture-funded companies were more likely to face fraud charges than companies that hadn’t taken venture funding, and that startups launched during overheated markets with weak oversight and investor due diligence were 19% more likely to later commit fraud.

Weiss’s paper, co-authored with Emlyon researcher Nevena Radoynovska, describes what can happen when founders face a gap between how investors want a startup to perform and how it actually performs. It outlines three escalating stages of what the paper calls “façading”: lying about a company’s success to investors, fabricating evidence such as fake contracts and revenue to back up those lies, and eventually misrepresenting the technology itself. But investors are not always victims: some, Weiss said, “co-create fraud” by continuing to back founders previously accused of it. The University of Toronto report found little evidence that alleged fraud stops founders from raising money again, even after cases drew major media attention, and that founder-controlled boards were twice as likely to see fraud as investor- or shared-controlled boards. VC-backed startups were also more likely to face securities class-action lawsuits within two years of going public than private-equity-backed companies.

Weiss wants the SEC to audit startups routinely once they cross a large investment threshold, rather than waiting for a whistleblower complaint or lawsuit, and argues investors should be held liable for governance failures and breaches of fiduciary duty.

Why it matters

If regulators and investors don’t change how they police outsized growth expectations, the current AI funding boom could produce a fresh wave of the same fraud patterns these two studies just mapped.