Jack Lu received eight proposals to make the first major investment in Magic Eden, his cryptocurrency start-up, but only one of them asked for a provision that is usually standard in similar tech deals: a seat on the company’s board.
By the end of the process this month, the cryptocurrency investment firm Paradigm had reached an agreement to lead a $27mn round of funding, ahead of well-known Silicon Valley firms including Greylock Partners and Sequoia Capital. Paradigm decided to not join the board.
“There was a deep level of trust between the two teams,” Lu said. “There was a lot of spiritual alignment in what we wanted to do.”
The arrangement is increasingly common in the freewheeling world of cryptocurrencies as investors compete to win stakes in hot start-ups poised to capture large shares of the rapidly expanding market.
More than 400 cryptocurrency start-ups have raised “Series A” financing without raising another subsequent round of funding in the past three years. Half of those had only one or two directors on their boards, according to an analysis by PitchBook, which uses public filings and company disclosures to compile the data.
Most start-ups in areas other than cryptocurrencies had at least three directors at that stage, according to the PitchBook data.
Venture capitalists said it had become normal to pass on board seats in companies focusing on digital assets. Many founders want to limit the involvement of outside backers. A wide swath of largely unregulated projects such as so-called “decentralised autonomous organisations” do not even have formal boards.
The result is that many cryptocurrency start-ups, one of the fastest growing areas of tech investment, have avoided the same amount of investor oversight as other large private companies.
A relaxed stance can help venture capitalists win deals and shield them from potential legal liabilities associated with risky projects. However, some investors said it could also foster bad governance practices.
“I think it’s very shortsighted,” said Rebecca Lynn, a general partner at Canvas Ventures. “We as investors have a fiduciary duty to our limited partners . . . and I’m not quite sure how that’s happening when you’re not on the board.”
Many cryptocurrency start-ups have been able to grow quickly without taking venture capital, allowing their founders to maintain a tight grip on operations. Even some of the best funded cryptocurrency companies have managed to avoid offering board seats.
Dozens of firms have invested more than $1.8bn across three financings in the cryptocurrency exchange FTX in the past year. The most recent round of funding valued the company at $32bn.
Yet by the end of the rapid fire rounds of dealmaking, none of the investors had secured a board seat at the three-year old exchange, according to a regulatory filing for FTX’s parent company.
Instead, the company has granted a board seat to a single outside director, an attorney based in its corporate home of Antigua and Barbuda. Its only other directors are FTX executive Jonathan Cheesman and 30-year old founder Sam Bankman-Fried, who confirmed the accuracy of the filing.
“We really value the relationships we have with our investors, but we also think that it’s important that governance reflect what is important for the company’s operations and oversight rather than monetary contributions,” Bankman-Fried wrote in an email.
FTX’s largest investors include Paradigm, Sequoia and the private equity group Thoma Bravo. Unlike many similar deals, none of the announcements for FTX’s financings named a “lead investor”, who usually invests the most money and takes a board seat.
Bankman-Fried said most of the company’s “key investors and stakeholders” belong to advisory boards for both FTX and the exchange’s US business, which meet quarterly.
Some investors said FTX did not need much formal guidance because it is already profitable, giving it the upper hand in deal negotiations.
“They grew so fast so quickly they had the affordance to skip a couple of these things,” said Chris McCann, a partner at the early FTX investor Race Capital.
FTX’s larger competitor, Binance, said it was preparing to establish a board “as we continue evolving from a disruptive tech company to a global financial institution”. It has been pitching to sovereign wealth funds and other large investors for outside financing.
Investors have sometimes avoided taking board seats at start-ups operating in sectors that could attract regulatory attention, such as decentralised finance.
Most DeFi projects release open-source software programmes and issue cryptocurrency tokens that allow users, investors and employees to vote on governance proposals. Many venture capitalists still end up owning large token holdings, giving them more influence than individual investors.
The umbrella group for global financial regulators took aim at the role of venture capital in DeFi this week, saying many enterprises were structured so that founders and investors could “make a profit while avoiding financial responsibility for the failure of a project”.
Some VCs said they had also become more relaxed about governance at other companies as start-up founders have gained more leverage in the past decade.
However, the frenzied pace of dealmaking in cryptocurrency start-ups in the past few years has stretched the limits of many top investors to an even greater extent.
Katie Haun, a cryptocurrency investor who raised $1.5bn for two new funds this week, said she did not plan to personally take board seats at many of the companies that receive her backing. Haun said she would focus on existing board seats at start-ups such as the NFT marketplace OpenSea.
Instead, she plans to delegate director positions to other employees at her new venture firm, Haun Ventures, while many of her investments will be in projects without formal boards. “I expect that a very significant percentage of our funds will be invested in tokens,” Haun said.
