VC-backed SV startups more likely to commit fraud, research finds

Venture capital-backed startups in the Silicon Valley are more likely to face fraud charges than companies that did not take institutional investment, and the outsized growth expectations imposed by investors are a significant contributing factor, according to two new academic papers published in June.

Research from Imperial College London and France's Emlyon Business School built a database of tech founders and companies who faced civil and criminal securities fraud prosecutions from the Securities and Exchange Commission, the US federal regulatory agency responsible for enforcing laws governing the buying and selling of securities, and the Department of Justice, the federal government body responsible for enforcing US law, between 2000 and 2023. A companion paper from the University of Toronto examined 654 fraud cases against US VC-backed startups across the same period, finding that startups launched during overheated markets with weak oversight and investor due diligence are 19% more likely to later commit fraud.

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The Emlyon paper describes a three-stage pattern it calls "façading." It begins with surface façading, in which founders exaggerate how well the company is performing. This can progress to reinforced façading, where fake evidence is created to back the lies, and then to deep façading, in which entire parallel realities are constructed, complete with fake demos and fabricated technical capabilities.

The University of Toronto paper found that startups controlled by founder-dominated boards were twice as likely to commit fraud as those with investor-controlled or shared boards. It also found little evidence that fraud allegations prevent founders from raising funding for subsequent startups, even when those allegations received significant media coverage. 

"New investors and the broader VC market do not penalise past misconduct," the paper concluded.