A study from Imperial College and Emlyon Business School examined how investors can help sustain fraud at venture-backed startups. Researchers described deception that can grow from exaggerated claims into fabricated business operations.
The report, published online in June, examined founders and companies facing securities fraud prosecutions, TechCrunch reported on July 31. Its findings challenged the view that founders alone account for wrongdoing.
Researchers Tracked How False Claims Escalate
The researchers built a database covering civil and criminal securities fraud prosecutions between 2000 and 2023. Those cases involved the Securities and Exchange Commission and Department of Justice.
Tim Weiss co-authored the paper with Emlyon researcher Nevena Radoynovska. Weiss told TechCrunch that fraud was more common and normalized in startups than people acknowledged.
The paper examined the gap between investors’ performance expectations and a company’s actual results. It described three increasingly dishonest stages using the term “façading.”
In the first stage, founders lie about a company’s success or prospects. The researchers distinguished those statements from an aspirational business vision or an expansive market estimate.
The second stage involves creating false evidence to support those claims. The paper described a mobile testing app that fabricated customer contracts, invoices and revenue.
According to the study, those documents helped persuade venture investors to back the company at a unicorn valuation. The example connected fabricated operating records with fundraising.
The third stage extends the deception to the technology itself, including fake demonstrations. Weiss described this as building “parallel realities” around false claims.
Investor Expectations And Repeat Backing Draw Scrutiny
Weiss said unreasonable expectations of rapid growth can contribute to founders’ misconduct. He identified the highly active AI startup market as conditions that could tempt founders into fraud.
Some investors also help normalize misconduct by continuing to support founders previously accused of fraud, the researchers found. Weiss described investors as sometimes unwittingly helping create it.
The report discussed a separate University of Toronto study covering 654 fraud cases against U.S. venture-backed startups. That study covered the period from 2000 to 2023.
It found little evidence that allegations prevented founders from raising money for another startup. That remained the case even when the allegations received substantial media coverage, according to TechCrunch.
Related coverage examines milestone-based startup funding, venture capital allocation and research commercialization funding.
The Toronto study found founder-controlled boards were twice as likely to be associated with fraud as investor-controlled or shared boards. It also found startups launched in overheated markets with weak oversight were 19% more likely to later commit fraud.
Weiss Called For Audits And Investor Accountability
Weiss proposed routine SEC investigations and formal audits once startups pass a large investment threshold. He said the agency typically waits for whistleblower complaints or lawsuits to prompt an investigation.
He also called for investors to take responsibility when pushing founders toward extreme growth targets. The paper suggested greater accountability for corporate governance failures and breaches of investors’ duties.
Weiss wanted further research into the relationship between entrepreneurs and investors. That work, he said, could help prevent fraud and reduce the emphasis on founders as its sole perpetrators.
