Researchers described how investor pressure can contribute to startup fraud in a report carried by Yahoo Finance. The study examined how founders move from exaggerated claims to fake evidence and deceptive technology demonstrations.
The report from the U.K.’s Imperial College and France’s Emlyon Business School was published online in June. Researchers built a database of tech founders and companies facing SEC and DOJ civil and criminal securities fraud prosecutions between 2000 and 2023.
Tim Weiss, an author, said fraud was more common and normalized in startups than people acknowledge. Weiss told TechCrunch that investors also help set and reinforce sometimes unreasonable expectations of high growth.
Yahoo Finance Report Describes Three Stages
Weiss co-authored the paper with Emlyon researcher Nevena Radoynovska. Their research discusses the gap between investors’ expectations and a startup’s actual performance.
Founders may respond through what the paper calls “façading,” according to the report on Yahoo Finance. The researchers identified three increasingly dishonest stages: surface, reinforced, and deep.
Surface façading involves founders lying about how successful a company is or is becoming. The paper distinguishes it from an aspirational vision or an astronomical estimate of a potential market.
Reinforced façading involves creating fake evidence to support those earlier lies. The paper described a mobile testing app that created false customer contracts and invoices.
The app recorded fake revenue and used those documents to persuade venture investors to back it at a unicorn valuation. In deep façading, founders may also exaggerate technology capabilities through fake demonstrations.
Weiss described that stage as creating entire “parallel realities” built on lies. The account connects dishonest claims with the supporting material presented to investors.
Investors And Founder Control
The researchers found investors were not always merely victims of founder misconduct. Weiss said some investors unwittingly “co-create fraud” by continuing to back founders previously accused of fraud.
The report also discussed University of Toronto research published in June. That study examined 654 fraud cases involving U.S. VC-backed startups from 2000 to 2023.
It found little evidence that allegations prevented founders from raising money for new startups, even after substantial media attention. It also found founder-controlled boards were twice as likely to commit fraud as investor-controlled or shared-controlled boards.
The Toronto study found startups launched in overheated markets with weak oversight and due diligence were 19% more likely to commit fraud later. It described fraud as rare overall, while finding greater exposure among venture-funded companies.
Grit Daily has separately covered research into startup fraud risks. Related coverage includes the Kalder founder charges and the Joonko securities fraud plea.
Proposed Audits And Investor Accountability
Weiss proposed that the SEC routinely investigate and formally audit startups after a large “investment threshold.” The report said investigations typically follow whistleblower complaints or lawsuits from investors or former employees.
The paper also suggests greater investor accountability for demands that founders meet extreme growth metrics. Weiss called for more research into entrepreneur-investor relationships to help prevent fraud and avoid treating entrepreneurs as the sole perpetrators.
