One of the pillars of capital markets is integrity, as it provides the assurance that underpins the ability to price, invest, and trade in securities at fair value and with timely execution.
All of that came into question at the start of the year when GameStop stocks soared to bewildering levels in a matter of days, despite steep quarterly sales declines as of late. By now, we all know the sudden surge was the result of stock market manipulation (in this case, driving up the price artificially with a sudden increase in public interest).
Whether a well-funded trading firm moves ahead of the market or a group of armchair traders band together to prompt retail investors to trade on imprudent information, massive amounts of public wealth can be lost due to untoward market antics. It should go without saying that market manipulation in any form undermines capital market integrity and could lead to foundation-eroding doubts about the true value of any business.
The Implications of Unethical Investment Strategies
Market manipulation, of course, is far from the only unethical investment behavior. Private equity segments have seen their fair share of ethical issues in venture capital, growth capital, leveraged buyouts, and so on. In the venture capital market segment, in particular, no set of standards has yet been widely adopted to guide VC professionals in their conduct — and this might be resulting in some questionable behaviors.
Firstly, fund creep leads to troublesome terrain. (This is when VCs characterize investment rounds with increasingly stringent revenue or development hurdles, resulting in a persistent slide in how the industry views startup stages.) Moving around the goalposts doesn’t make seed investing any less profitable in the long run. Still, many Series-A-and-beyond firms choose to consider only companies with ever more traction.
On the surface, increased selectivity seems like a solid approach. However, continually ratcheting risk tolerance lower in order to raise bigger funds is a departure from the tenets of venture capital investing, and it widens the chasm promising early-stage companies need to cross before raising growth-stage capital.
Herd mentality is yet another ethical issue that isn’t limited to the stock market. All investor segments, including venture capital, show evidence of following others’ leads. The GameStop frenzy would fall into this category, as would other investment fads (such as certain cryptocurrencies).
Although we all consider ourselves impartial and specialized actors, many of us end up investing as the collective does. These moves could pay off, but they might also cause an artificial boom that could quickly bust if prices far outweigh the true value of the underlying fundamentals.
Additionally, there’s a preponderance of behavior simply characterized as poor conduct within the VC community. VCs show up late to meetings, don’t apologize, tell founders how to build their products after a single session, dole out a series of rote questions, and tune out as founders offer heartfelt responses. Some VCs even deign to venture outside their “sweet spot,” asking founders whether they actually understand what they’re building.
Needless to say, questionable and unethical investment behaviors are detrimental to all parties involved. For founders, it could leave their venture hunting for funding that never comes or having no choice but to accept sudden changes in terms that relinquish some financial advantage.
On the other side of the negotiating table, early-stage investors can find themselves in the unfortunate position of losing their pro rata rights when later-stage VCs claim all of the room on the table. And when word of such bad behaviors gets out, consumers take notice — eroding the already spotty reputation of venture capital as a grown-up capital market.
Ethical Venture Capital: Principles of Investing
To combat unethical investment behaviors, the team at Ascend proposes those in the VC sector make a commitment to abide by a venture capital code of ethics. When applied voluntarily, such a code would provide a framework of what constitutes ethical investing, all while promoting professional behavior throughout the industry. These are the key tenets we propose:
- Act ethically and with integrity.
- Prioritize investors’ interests over personal interests.
- Administer job obligations (e.g., investment analysis and recommendations) with care and good judgment.
- Act professionally and encourage professional behavior in others.
- Strengthen the integrity of capital markets and abide by the rules that govern them.
- Sustain and develop professional knowledge.
Committing to such principles and enlisting others to take up the cause would go a long way toward establishing a much more sustainable environment for investors and founders alike. Trust, as they say, is hard-won — yet easily lost. Collectively, we can ensure the integrity of investment practices by letting these principles guide each interaction and transaction going forward.
Reputation is everything. It precedes VCs in nearly every deal and can affect the decisions of limited partners, founders, and others in the startup community. This is why a commitment to abide by a code of conduct just makes sense.
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