'FOMO fundraising' and 'orange flags': Bankman-Fried's lust for risk was obvious

Overheard, in a Manhattan federal courthouse:

"We're all waiting for Caroline to testify."

"I just came to watch Caroline."

"Have you read her Tumblr posts? I want to see her diary entries."

The anticipation was palpable on Tuesday afternoon when Caroline Ellison, former CEO of Alameda Research, finally took the stand in the federal fraud trial of disgraced FTX founder Sam Bankman-Fried.

Ellison, 28 and Bankman-Fried's former on-and-off girlfriend, oversaw many of Alameda's risky bets from the infamous FTX house in the Bahamas, allegedly under SBF's direction. She's now part of crypto lore.

Following the courtroom drama alongside me has been a mix of press, tech founders, hacks and passersby. Even "pharma bro" and convicted fraudster Martin Shkreli has come down to the courthouse.

Ellison's lengthy testimony this week revealed Bankman-Fried's remarkable capacity for risk-taking from the viewpoint of one of the people who knew him best. Bankman-Fried would brush aside company governance questions and insist upon quick-turnaround term sheets, playing into investors' FOMO while cultivating an image as a Zuckerberg-esque eccentric. Many investors looked past the red flags and did only light-touch due diligence, perceiving his penchant for risk as a mark of ambition, rather than recklessness.

When Bankman-Fried wanted to make $3 billion in venture investments—a sum that would cement him as a tycoon of the decentralized banking revolution, on par with the likes of Andreessen Horowitz and Sequoia—Ellison ran the numbers. According to her testimony, she calculated that there was a "100% chance" that Alameda would not be able to repay its lenders if they recalled its loans. That was the case even if Alameda dipped into FTX customer funds, billions of dollars of which they were allegedly spending on expenditures, political donations and risky investments.

The company went on a startup-investing spree anyway.

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"He wanted to go ahead," Ellison told a crowded downtown Manhattan courtroom.

Bankman-Fried's venture bets ranged from blockchain startups like Bored Apes NFT pioneer Yuga Labs and Bitcoin mining giant Genesis Digital Assets, to funds of VC firms like Sequoia and SkyBridge Capital, the investment shop run by financier and former White House communications director Anthony Scaramucci.

Ironically, FTX's $500 million stake in generative AI company Anthropic, which is reportedly raising a $2 billion round at a $20 billion valuation, is now so valuable that it could've gone a long way to filling the hole in FTX's balance sheets, had the crypto exchange not imploded in November 2022.
   
Early investors pushed back on, but ultimately looked past, FTX's lack of a board of directors or CFO, as well as its suspiciously close relationship with Alameda Research.

Along the way, Bankman-Fried convinced blue-chip investors like Sequoia, SoftBank and Insight Partners that he was the real deal. 'FOMO' vs. 'orange flags'
Bankman-Fried leveraged the bull market to his advantage: during fundraising, he would warn investors that a round had nearly closed or refuse reasonable due diligence questions due to time constraints, according to Alex Pack, now managing partner of Hack VC. Hack, in an interview, told me he considered but ultimately passed on investing in Alameda Research in 2019 while he was at crypto VC firm Dragonfly Capital.

"Sam was the master of FOMO fundraising," Pack said. In 2020 and 2021, there was a widespread sense that investors were at the mercy of the markets because deals were closing so quickly—in some cases, in mere days.

The FTX trial has also laid bare Sand Hill Road's bias towards the disheveled visionary with a math degree from MIT and a stint at the famous quant shop Jane Street.

"You just had to open your browser to see it was run by very young, inexperienced people," Alyssa Misner, a corporate investigator at Washington firm Control Risks, told me. "There were a lot of orange flags that certainly warranted investors to slow down,” Misner added in our interview, citing for one, that 20 top FTX and Alameda executives lived together in a $35 million luxury resort in the Bahamas for the final few years of FTX's existence.

Misner raised her concerns about FTX to a sophisticated institutional investor client in the summer of 2022. Her client eventually went elsewhere for pre-investment diligence— "and they got stung," she said.

According to Caroline Ellison,  Sam Bankman-Fried used to say that he would flip a coin "if tails meant that the world was destroyed, if heads meant the world would be twice as good."

Over the last decade, more investors have taken extra steps in their corporate due diligence efforts. It's become much more common, Misner said, for investors to go as far as asking for discreet inquiries with sources before making an investment, such as with a company's former employees or a founder's former business associates. The Catch-22 is that if a founder discovers this, it can burn a cornerstone of the ecosystem—a VC's reputation and good relationships with founders.

Some investors in FTX, such as Sequoia, promised to LPs after FTX's collapse that they would improve their due diligence processes. But with the temptation to strike when the iron is hot, the question is whether investors will relax their oversight when a bull market returns.

Before FTX, there was Theranos. The bandwagon fallacy and FOMO are two powerful forces in the industry that incentivize GPs to invest first and ask questions later when considering the hottest companies. Flipping a coin FTX may not be a turning point for the investor industry writ large, but it is almost certainly one for crypto. The sector's deal value is down 44% this year, according to PitchBook.

"We often tell our investors we're living in a post-FTX fundraising world," Pack said, where GPs have more leverage, deals are taking longer to close and especially in blockchain, people are more paranoid about getting burned. It's a tumultuous period for firms that had to swallow big losses during the crypto winter.

Last week, I reported that a former FTX investor, $4 billion crypto firm Pantera Capital, had lost its third high-profile executive in a little over a year.

VCs are used to taking unorthodox risks, because they're actively seeking moonshot rewards. An appetite for bold risk-taking can be an alluring quality in a prospective founder.

Bankman-Fried's investment in Anthropic was exactly the type of risk that would make VCs green with envy had FTX survived long enough to reap the gains.

According to Ellison's testimony, Bankman-Fried used to say that he was the type of risk-taker who would flip a coin "if tails meant that the world was destroyed, if heads meant the world would be twice as good."

The line drew chuckles in the courthouse. But it's the ones who did the real due diligence on FTX who got the last laugh.

Featured image by Joey Schaffer/PitchBook News
 

This article originally appeared on PitchBook News