How To Speak Venture
A letter from FTX's most conservative investor explains why they'll do it again.
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Earlier this week, I highlighted the lessons that venture investors learned from the FTX fiasco:
Given the opportunity, most of FTX's investors would do exactly the same thing tomorrow. Their job is not to avoid failure; it is to avoid missing out on the biggest success.
It is also their job to say they learned their lesson before they do it again.
Yesterday, one of FTX's largest investors published a statement that corroborates my theory. Temasek Holdings invests and oversees around $300 billion on behalf of the Singaporean government. It is one of the world's most reputable and sought-after investors. It's big, disciplined, and — in its own words — "a generational investor" with an eye toward the long term.
In other words, Temasek is not a bunch of reckless pirates. And yet, its statement about FTX explains why investors will continue to take risks that seem unreasonable when they don't pan out.
The statement elaborates on the investment process:
"we conducted an extensive due diligence process on FTX, which took approximately 8 months from February to October 2021. During this time, we reviewed FTX’s audited financial statement, which showed it to be profitable. In addition, our due diligence efforts focused on the associated regulatory risk with crypto financial market service providers, particularly licensing and regulatory compliance (i.e. financial regulations, licensing, anti-money laundering (AML)/ Know Your Customer (KYC), sanctions) and cybersecurity. Advice from external legal and cybersecurity specialists in key jurisdictions was sought, with legal and regulatory review done for the investments.
Separately, we also gathered qualitative feedback on the company and management team based on interviews with people familiar with the company, including employees, industry participants, and other investors."
This makes perfect sense. Most people think that due diligence is some FBI-style forensic investigation. In reality, it consists of reviewing lots of documents, talking to some people, and getting a bunch of consultants and service providers to tick a bunch of boxes. If a CEO or executive team lie, produce forged documents or hide material information, an investor cannot and is not expected to know any better.
The statement also explains the relative size of the bet in the context of the whole portfolio:
"The cost of our investment in FTX was 0.09% of our net portfolio value... as of 31 March 2022."
Finally, Temasek's statement adds a little spin to make the whole thing seem even more reasonable than it actually was:
"There have been misperceptions that our investment in FTX is an investment into cryptocurrencies. To clarify, we currently have no direct exposure in cryptocurrencies."
This is hilarious. Imagine investing in Pornhub and saying, "we have no direct exposure to pornography." You made a bet; own it! But, as I pointed out above, it is part of the investor's job to say they learned a lesson.
Also note that awkward grammar: The statement says "we have no direct exposure in" when the correct English is "no direct exposure to." This seems like something a lawyer would write in anticipation of legal trouble. The kind of stuff that allows you to say, "we never said we have no exposure to crypto."
In short, the statement described the standard procedure: Going in: cover your behind, tick all the boxes, and size your position appropriately. Running out: describe your process and try to reframe your initial decision. Then, do it again.
This is not meant as a criticism. It looks like Temasek did everything right. And their statement concludes in an honest and direct manner:
"We continue to recognize the potential of blockchain applications and decentralized technologies to transform sectors and create a more connected world...
There are inherent risks whenever we invest, divest, or hold our assets, and wherever we operate...
We will continue to remain prudent and exercise caution even as we explore opportunities that are aligned with our structural trends, to deliver sustainable returns over the long term for our overall portfolio."
If you're looking for financial returns, you have no choice but to take risky bets. These bets, by definition, include investment in companies and entrepreneurs that are pushing boundaries and operating in legal gray areas.
Our future well-being depends on investors that finance crazy ideas. But it also depends on laws that punish executive teams that lie, steal, and forge documents. As of this morning, the founder of FTX is still a free man and was not called in for investigation by the US or other authorities. If you're looking for an outrage, start with that.
🎧 An audio version of this article is available on Spotify, Apple Podcasts, and beyond.