The Dark Side of Venture Capital: Five Scams to Watch Out For
Demystifying the complex world of Venture Capital Scams, this article unveils five cunning strategies used by fraudsters. It offers valuable insights into spotting red flags and protecting your investments, supplemented with real-world scam examples. An essential read for any aspiring investor.
Author Frederik Van Lierde • Tuesday, May 30, 2023 • Impressions: 755
Phantom Ventures, as the name implies, involves scams built around nonexistent businesses. The scammers create an elaborate facade of a startup, complete with professional-looking websites, fictitious executive profiles, and seemingly impressive financials. The trap is set for investors seeking to cash in on the ground floor of a promising startup.
The case of BigFunds, a purported venture capital firm that lured investors with promises of high-yield returns from its portfolio of tech startups. However, investigations revealed the startups to be fictitious, leaving investors with substantial financial losses.
Protection Against Phantom Ventures
When considering investment in a new venture, it's crucial to conduct thorough due diligence. You can do this by independently verifying the company's claimed registrations and the identities of the individuals involved. Speak with professionals in the field who can provide insight into the viability of the company’s product or service. Reach out to trusted advisors or investment professionals who can help analyze the proposed business plan.
2. Ponzi Venture Scheme
In Ponzi Venture Schemes, the tricksters use money from new investors to provide returns to earlier investors. This type of scam creates the illusion of a successful investment while in reality, the funds are continually being drained.
The infamous Bernie Madoff scandal is a stark example. While not strictly a VC, Madoff’s investment firm promised unusually consistent returns and used new investors' capital to pay off earlier investors.
Protection Against Ponzi Venture Schemes
Protecting yourself from Ponzi schemes involves looking out for red flags, such as promised consistently high returns and unregistered investments. It's essential to ask for and review all documentation about the investment. Finally, if returns or dividend payments are late or missing, this could be an early sign of a Ponzi scheme, and it may be wise to withdraw your investment.
3. Fabricated Returns
Scammers using this strategy present inflated or entirely fabricated returns on investments. By showcasing exceptional, often too-good-to-be-true performance, they lure unsuspecting investors into their trap.
Theranos demonstrated this type of scam. The health tech company misrepresented its technology's capabilities and potential profitability, leading to massive losses when the truth surfaced.
Protection Against Fabricated Returns
To protect yourself from scams involving fabricated returns, always research independent sources to verify claimed returns. This can involve looking at industry benchmarks, historical data, and the returns of similar investments. Be wary of ventures that promise guaranteed high returns – investments inherently involve risk, and such promises are often a red flag.
4. Fictitious Products
This strategy involves inventing a product or service that does not exist or vastly exaggerating its potential. By creating a convincing pitch for a groundbreaking product, scammers can secure substantial investment for their nonexistent product.
The case of Juicero, a startup that raised around $120 million for a juicing device touted as revolutionary. However, the product turned out to be significantly overhyped and underperforming, leading to investor losses.
Protection Against Fictitious Products
In the case of potential scams involving fictitious products, consider seeking expert opinion on the product's feasibility and market potential. Conduct thorough research to verify the existence and functionality of the product. Furthermore, demand to see a working prototype or beta version of the product before investing.
5. Extortion through Short and Distort
Short and distort scams involve spreading negative rumors or misinformation about a company after taking a short position in it. As the company's stock value plummets, the scammer profits from the decrease.
An anonymous blogger named Iceberg Research orchestrated a short and distort scheme against the commodity company Noble Group, spreading negative reports that led to a sharp decline in Noble Group's stock.
Protection Against Short and Distort Scams
In order to protect yourself from 'Short and Distort' scams, it's important not to make investment decisions solely based on rumors or information from non-credible sources. Always consider the source of any negative news and check the information against reliable news outlets or direct company reports. Monitor the market for abnormal activities and invest only in ventures and stocks that have demonstrated transparency and credibility.
The complexities of the venture capital world, coupled with the potential for high returns, often make it a prime target for scams. These scams, ranging from phantom ventures to short and distort tactics, can be mitigated through due diligence, skepticism of 'too good to be true' offers, and verification of all claims.