Starting from Paradigm, venture capital firms' control over invested crypto companies is weakening

Original Author: Miles Kruppa, Financial Times

Original Title: 《Venture capitalists pass on board seats to secure deals in hot crypto start ups》

Translation by: Nian Yinsi Tang, Odaily Planet Daily

In the development of the Web2 internet, venture capital firms have always been heavily involved in the business direction, personnel appointments, and development pace of their portfolio companies, with major investors typically holding a seat on the board. However, this trend is changing in the investment landscape of Web3 and the crypto industry, with many institutions becoming "hands-off" purely financial investors.

Jack Lu received eight proposals for a significant initial investment in his cryptocurrency startup Magic Eden, but only one requested the standard terms typically seen in similar tech deals: a seat on the company's board of directors.

As of the end of this month, the cryptocurrency investment firm Paradigm has agreed to lead a $27 million financing round for Magic Eden, with other participants including well-known Silicon Valley firms like Greylock Partners and Sequoia Capital. Paradigm decided not to join the board.

"We have a deep trust between us," Lu said, "and there is a lot of spiritual alignment in what we want to do."

This arrangement is becoming increasingly common in the freely developing world of cryptocurrency. Investors are competing to acquire stakes in hot startups, which are also eager to capture significant market share in a rapidly expanding environment.

In the past three years, over 400 cryptocurrency startups have completed Series A financing without raising the next round of funding. An analysis by PitchBook shows that half of these companies have only one or two board members. Note: PitchBook compiles data using public documents and company disclosures.

According to PitchBook's data, most startups outside the cryptocurrency sector have at least three board members at this stage.

Venture capitalists indicate that giving up board seats has become the norm among companies focused on digital assets. Many founders wish to limit the involvement of external supporters. Many essentially unregulated projects, such as the so-called "DAOs," do not even have a formal board.

The result is that many cryptocurrency startups—one of the fastest-growing sectors in tech investment—are avoiding as much investor oversight as other large private companies.

This relaxed stance can help venture capitalists win deals and spare them from potential legal liabilities associated with risky projects. However, some investors say this could also foster poor governance practices.

"I think this is very shortsighted," said Rebecca Lynn, a general partner at Canvas Ventures. "As investors, we have a fiduciary duty to our limited partners… I don't know how we can fulfill that when we are not on the board."

Many cryptocurrency startups are able to grow rapidly without accepting venture capital, allowing their founders to maintain strict control over operations. Even some of the most well-funded cryptocurrency companies have managed to avoid offering board seats.

In the past year, dozens of companies have invested over $1.8 billion in the cryptocurrency exchange FTX through three funding rounds. In the most recent round, the company's valuation was $32 billion.

However, a document submitted to regulators by FTX's parent company shows that at the end of a rapid transaction facilitation round, no investor obtained a board seat at the exchange, which was founded three years ago.

Instead, the company only granted one external director a board seat, who is a lawyer based at the company's headquarters in Antigua and Barbuda. The other directors are FTX executives Jonathan Cheesman and 30-year-old founder Sam Bankman-Fried (SBF), who confirmed the accuracy of the document.

"We really value our relationship with investors, but we also believe it is important that corporate governance reflects aspects that are important to the operation and regulation of the company, rather than just 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, FTX's financing announcement did not mention a "lead investor." The lead investor typically invests the most and receives a board seat.

SBF stated that most of the company's "key investors and shareholders" belong to FTX and the exchange's U.S. business advisory committee, which meets quarterly.

Some investors say FTX does not need much formal guidance because the company is already profitable, giving it an advantage in deal negotiations.

"They have grown so quickly that they are able to skip over a few things," said Chris McCann, a partner at Race Capital, which invested early in FTX.

FTX's competitor Binance stated, "As we continue to evolve from a disruptive tech company to a global financial institution," the company is preparing to establish a board. Binance has been seeking external financing from sovereign wealth funds and other large investors to support its growth.

For startups that may attract regulatory attention, such as those in the DeFi space, investors sometimes also avoid entering the board.

Most DeFi projects release open-source software programs and issue cryptocurrency tokens, allowing users, investors, and employees to vote on governance proposals. Many venture capitalists still hold significant amounts of tokens, giving them more influence than individual investors.

The International Organization of Securities Commissions (IOSCO) this week targeted the role of venture capital in DeFi, stating that the structures of many enterprises allow founders and investors to "profit while avoiding financial responsibility for project failures."

Some venture capital firms say that as startup founders have gained more influence over the past decade, they have also become more relaxed about governance in other companies.

However, the frenzied pace of financing for cryptocurrency startups in recent years has expanded the limitations for many top investors.

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

She plans to delegate board positions to other employees of her newly established venture capital firm, Haun Ventures, while many of her investment projects do not have formal boards. "I expect a large portion of our funding will be invested in tokens," Haun said.