Fish and bear’s paw: VCs give up board seats to enter hot crypto startups

Jack Lu received eight proposals for its first major investment in cryptocurrency startup Magic Eden, but only one of them called for a clause that is often standard in similar tech deals: a seat on the company’s board.

As of the end of this month, cryptocurrency investment firm Paradigm has reached an agreement to lead a $27 million financing round in Magic Eden, with other investors including Greylock Partners and Sequoia Capital, well-known Silicon Valley companies. Paradigm decided not to join the board.

“There’s a deep trust between us,” Lu said, “and there’s a lot of spiritual alignment in what we want to do.”

This arrangement is increasingly common in the freely evolving cryptocurrency world. Investors are vying for stakes in hot start-ups that are also poised to grab big chunks of a fast-expanding market.

Over the past three years, more than 400 cryptocurrency startups have closed “Series A” rounds without raising the next round. An analysis by PitchBook showed that half of these companies have only one or two directors on their boards. Note: PitchBook uses public filings and company disclosures to compile data.

According to PitchBook, most startups outside the cryptocurrency space have at least three directors at this stage.

Among companies focused on digital assets, giving up board seats has become the norm, venture capitalists say. Many founders want to limit participation from outside backers. Many largely unregulated projects, such as so-called “DAOs,” don’t even have a formal board of directors.

As a result, many cryptocurrency startups—one of the fastest-growing sectors of tech investment—have avoided as much investor scrutiny as other large private companies.

A relaxed stance can help venture capitalists win deals and shield them from potential legal liability associated with risky projects. However, some investors said it could also foster poor governance practices.

“I think it’s very short-sighted,” said Rebecca Lynn, general partner at Canvas Ventures. “As investors, we have a fiduciary duty to LPs…I don’t know how to do that when we’re not on the board. “

Many cryptocurrency startups have been able to grow rapidly without accepting venture capital, which allows their founders to tightly control operations. Even some of the most well-funded cryptocurrency companies have managed to avoid offering board seats.

Over the past year, dozens of companies have invested more than $1.8 billion in cryptocurrency exchange FTX through three funding rounds. In its most recent funding round, the company was valued at $32 billion.

However, a filing by FTX’s parent company with regulators shows that at the end of a quick round of dealmaking, no investor was given a board seat at the three-year-old exchange.

Instead, the company gave only one board seat to an outside director, a lawyer at the company’s headquarters in Antigua and Barbuda. The only other directors were FTX executive Jonathan Cheesman and 30-year-old founder Sam Bankman-Fried (SBF), who attested to the accuracy of the documents.

“We really value investor relations, but we also believe that it is important that corporate governance reflects aspects that are important to a company’s operations and regulation, rather than financial contributions,” SBF wrote in an email.

FTX’s largest investors include Paradigm, Sequoia Capital and private equity group Thoma Bravo. Unlike many similar deals, none of FTX’s funding announcements mentioned a “lead investor.” The lead investor typically invests the most and gets board seats.

SBF said most of the company’s “key investors and shareholders” belong to advisory boards for FTX and the exchange’s U.S. operations, which meet quarterly.

Some investors say FTX doesn’t need much formal guidance because the company is already profitable, giving it the upper hand in deal talks.

“They’ve grown so fast that they have the ability to skip a few of those things,” said Chris McCann, a partner at Race Capital, an early investor in FTX.

FTX rival Binance said it was preparing to form a board of directors “as we continue to evolve from a disruptive tech company to a global financial institution.” Binance has been seeking outside financing from sovereign wealth funds and other large investors.

And for startups that might attract the attention of regulators, such as in the DeFi space, investors sometimes avoid boardrooms.

Most DeFi projects release open-source software programs and issue cryptocurrency tokens that allow users, investors, and employees to vote on governance options. Many venture capitalists still end up holding a lot of tokens, which makes them more influential than individual investors.

The International Organization of Securities Commissions (IOSCO) this week took aim at the role of venture capital in DeFi, saying that many businesses are structured in such a way that founders and investors can “make profits without taking on the finances for project failures” Responsibility”.

Some VCs say that as startup founders have gained more clout over the past decade, they have also become more relaxed in their governance of other companies.

However, the frenzied funding rate of cryptocurrency startups over the past few years has widened the limits of many top investors.

Cryptocurrency investor Katie Haun raised $1.5 billion this week for two new funds. She said she does not plan to take on board seats at many of the companies she supports herself. Haun said she will focus on existing board seats at startups, such as NFT marketplace OpenSea.

She plans to delegate directorships to other employees at her new venture capital firm, Haun Ventures, and many of her investments do not have formal boards. “I expect a significant portion of our funds will be invested in tokens,” Haun said.

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