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Lessons from the Madoff Mess

The Madoff Mess can provide some important lessons for any investor.  And, every entrepreneur is an investor of either their own money or, more valuably, their time.

Luckily, there virtually no evidence of outright fraud in the venture capital business.  VC deals are well documented, venture funds are generally audited by top-tier accounting firms, and almost every venture-backed deal is also audited by well-established firms.  So, the lessons learned aren't about fraud, but about verifying the facts.

"Trust But Verify" is often attributed to Ronald Reagan.  He certainly used it very often.  And, these are good watchwords for every entrepreneur.  Some examples:

  • Don't just trust your VCs reputation.  Verify it through your own diligence, including blind reference checks and discussions with executives of companies that didn't work out.
  • Don't trust your VC when she agrees to some additional terms that aren't on the term sheet or promises to 'take care of you' if you are let go.  Verify every deal and agreement with terms in writing.  You never know if the person you make the agreement with will be the one you have to enforce it with.  If the deal is really a deal, no one should object to putting it in writing.
  • Don't trust that your VCs will fund your company if you can't raise money elsewhere.  VCs will always promise support for your company, but that isn't the same as wiring funds into your account.  If the VCs are promising to backstop your company with a bridge financing in the event that you can't raise money, get that agreement in writing, including the terms.  Once your company is actually on the brink, the terms may change.  But, if you have a prior agreement, hopefully it will be honored.
  • Don't trust the commitments that are promised by customers and partners.  Follow-up with emails confirming, or formal contracts if appropriate.  It may seem overly formal during more friendly relations, but the actual commitment may give you some moral high ground if the going gets tough.

From the looks of it, Madoff's investors (and "friends") trusted him without verifying his results.  It seems like no auditing of his transactions was done.  When you are dealing with 10s and 100s of millions of dollars, you have to verify the results.  A true friend or honorable money manager would never object.

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Comments

Mike,
Jack Bogle must read your blog. He was on SquakBox this morning and used the term, "Trust but Verify," several times when referring to the Madoff mess. I agree with your advice to entrepreneurs, but want to add that Trust but Verify extends into the entrepreneurial organization itself in particular as it relates to direct and channel sales. The pressures on salespeople to make their numbers can cause them to be overly optimistic at a minimum. This also applies to development, where the readiness of a product can be difficult to measure in some organizations. What it all boils down to is the need for policy and procedures to gain some balance between Growth, Profit and Control.

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