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Technology & Leadership

Entrepreneurial Optimism Versus Fraud

Nate Lentz
October 14, 2021

Everyone talks about an entrepreneurial culture of “Fake it until you Make It” and how things can go wrong if this is taken too far.  The instances of fraud in venture investments goes well beyond what has been alleged at Theranos and Ozy.  Pick a vibrant venture ecosystem and there will be stories with some told publicly and other shared privately.  The DC / VA / MD community has several recent examples.

Entrepreneurs are expected to have extremely lofty goals and extremely optimistic projections.  They are expected to put together future views of their success where everything needs to go right.  This is entrepreneurial optimism and as investors we expect to see this, as we want to know how big an opportunity can be and what is possible.  We then take these perspectives and bring them down to earth when we run our financial models and our Monte Carlo simulations.  You could call this investor realism, which is baked into our diligence processes.

Looking backward, however, entrepreneurs are not expected to stretch the truth or use their imagination about where their company has been.  They are not expected to inflate revenue, or deflate costs, or reduce data on churn, or wipe a year-end balance sheet of overdue receivables.   They are not expected to doctor financials or operating metrics or to fake customer references or to fill office desks with family members during an investor site visit.  This would not be entrepreneurial optimism.  It is fraud.  And if it happens during the sale of stock, it is securities fraud.

Private equity firms and later stage growth funds have historically done deep diligence on financials with quality of earning studies and a requirement of audited financials.  Early stage investors have typically been more relaxed about financial diligence and the source of other company generated metrics.  At Osage Venture Partners, we conduct a third-party financial review as part of our diligence to confirm accounting practices and to follow the flow of dollars to confirm the magnitude of billings and expenses.  We dig into the underlying raw data beyond what is reported to us so that we can calculate our own metrics on churn, metrics on pipeline, and metrics on people retention.  We also read Glassdoor and G2 to see what employees and customers say.   Our “trust but verify” approach gives us some comfort but we are not naïve enough to think that we won’t be fooled by a team with the talent and will to mislead us.

Entrepreneurs should remember – the future is under your control and you can shape the outcome and shape the story.  This is where creativity and passion can drive an exciting vision for the business you have built and are building.  But also remember – the past is the past and it is fixed for all time.  Historical metrics and financials and other data cannot be altered with passion or desire.  Wishing it were different will not change anything.  Lying about it can get you into serious trouble.   Especially when you are lying to a potential investor.