Last week, Fortune reported on the downfall of IRL, a social app startup that, after surpassing $1 billion in valuation a few years ago, said it was shutting down because 95% of its users were fake. This week, venture capitalists weighed in on the debacle, focusing on how investors got so wrong.
IRL joined the ranks of the unicorns – companies with private valuations of at least $1 billion – thanks to a $170 million Series C funding round led by SoftBank Vision Fund 2 (returning investors included Goodwater Capital, Founders Fund and Floodgate), bringing his total raised to over $200 million. Suspicions over his ‘zombiecorn’ status grew after CEO Abraham Shafi resigned in April following allegations by employees of inflated user numbers.
On the All-in friday podcast, venture capitalists discussed the investor’s due diligence – or lack thereof – which should have revealed the inflated number of IRL users.
A key role for venture capital is to “ask uncomfortable questions and do uncomfortable due diligence,” said angel investor Jason Calacanis. “You can trust the founders, but you have to check that the data you have is correct.”
David Sacks, General Partner of Craft Ventures, added, “I would say for us the first part of due diligence, other than looking at metrics, what anyone can do is off-sheet benchmarks: talking to customers from a list that you found yourself, not from the company itself. »
Chamath Palihapitiya, who founded venture capital firm Social Capital in 2011, pointed to insufficient checks and balances and what he sees as “deeply inexperienced” VCs, who he says “don’t even know how to ask the basic questions or – even more insidiously – you don’t have the courage to say the hard thing.And so these things happen that are frankly inexcusable.
He added that while venture capital may look easy on the outside, “in practice, there are only a few legends in our business.” And when it comes to pushing in a boardroom or in the middle of a stagecoach, he says, “inexperienced people” may lack the seriousness to challenge a startup’s executives.
“There must be a conflict,” he said. “I think that’s a necessary characteristic of good decisions, and that conflict happens internally within your investment team, but it also has to come externally with the executives of the startup and with the CEO themselves. “
Investors also pointed to the size of the SoftBank Vision Fund as an issue. The original fund, founded in 2017, raised more than $100 billion in capital.
“When they make a mistake, it’s 20 times bigger than it should be,” Sacks said. IRL “should have been maybe a $10 million mistake…but the size of their fund compelled them to write these gigantic checks.”
The size of these funds can increase “because you get paid an annual management fee, and so obviously the way to make more money is to get 2% on a bigger fixed number every year versus 2% on a fixed number smaller,” Palihapitiya said. .
Palihapitiya, a former Facebook executive, is himself associated with the abuses of Silicon Valley. The billionaire earned the nickname “SPAC King” for bringing a number of high-risk startups – most of which did not do well – to market through his special-purpose acquisition companies.
The big funds, he said, “get the 2%, and all of a sudden the profits don’t matter, which means the results don’t matter, which means the diligence is superficial and it becomes a theatrical exposition…that kind of thin fig leaf, you can point to the vinyl records and say, “We’ve done our job here, give us more money for this next fund.” This is the mad rush the venture capital community finds itself in, and it’s going to play out at companies like IRL.
It will also play out, he added, with the current wave of new AI ventures, but “we are early in the hype cycle” with artificial intelligence.
