There is no question that angel investing plays a critical role in the startup ecosystem, providing crucial funding to entrepreneurs and fueling innovation--all which creates jobs and sustainable economic growth. While there is a high level of risk in early-stage investing, it has proved remarkably resilient in the face of the fallout from Silicon Valley Bank and recent economic challenges. It is true that angel investing can provide significant returns, but the reality is a majority of these investments will fail to ever return capital to the investors.
But failure alone is not fraud. This is the point of a recent post put out by the Angel Capital Association ("ACA") and echoed in the Startup Catalyst Brief. While the media may focus on high-profile examples of venture fraud such as Theranos (see literally any Theranos search results on Google), actual instances of fraud in the early-stage angel investment space are far less common than the page six appearances by Elizabeth Holmes.
That said, much like any commercial activity, fraud does happen and is a risk that should be taken seriously (however slight the actual chances may be). This is a point that though acknowledged by ACA board member John Harbison in his blog post, seems to be a bit downplayed. Sure, the risk of failure due to fraud may be very low, but that is not the same thing as providing overall instances of fraud regardless of whether they result in failure.
Perhaps that is simply a result of my perspective as a lawyer but fraud that doesn't result in failure should still be factored into the risk paradigm. Inevitably some entrepreneurs will exaggerate their projections, overstate their market traction and abilities, or misrepresent their business in order to attract investment. Others meanwhile may embezzle funds or misappropriate company IP and assets. Further complicating the matter, identifying the exact line between blind optimism leading a startup and fraud can be a exacting task even for an experienced lawyer. Fortunately, the risk of fraud (whether likely to result in failure or not) can often be mitigated through good governance, transparency, financial controls, and thorough due diligence.
With more leverage now than at any point in recent memory, it is crucial for investors to be cautious and take necessary steps to mitigate any risk of failure--including potential fraud.
Failures are quite common in early-stage investing, but the reason for failure almost never is because of fraud. While fraud equates to failure, failure does not equate to fraud: It is critical to understand that failure comes in multiple non-fraudulent forms.