Silicon Valley Poured Money Into FTX, With Few Strings Attached

FTX Chief Executive

Sam Bankman

-Fried told several investors on a call Wednesday that he needed emergency funding to cover a shortfall of up to $8 billion, The Wall Street Journal reported. Mr. Bankman-Fried said he hoped FTX could raise as much as $3 billion to $4 billion in equity. 

That would be a tall order for a financial company of FTX’s size in normal conditions. Its previous largest funding round was $1 billion in mid-2021, when crypto was booming and investors clamored to get into the company many viewed as among the world’s hottest startups. 

Besides Sequoia, dozens of others backed FTX’s rise, including Ontario Teachers’ Pension Plan,

SoftBank Group Corp.

9984 1.76%

, a venture-capital arm of

Samsung Electronics Co.

,

Dan Loeb’s

Third Point LLC, Tiger Global and football star Tom Brady. 

Sequoia said in a letter to fund investors it ran a “rigorous diligence process” on FTX and its loss was small in the context of a fund with billions of dollars of profits. “We are in the business of taking risk,” the firm said. 

An FTX spokesman declined to comment. 

The rapid unraveling of FTX shows the pitfalls of investing in a frenzy. Attracted to a founder they saw as visionary, investors moved swiftly to commit, putting aside some customary oversight safeguards, according to people familiar with the company. 

Mr. Bankman-Fried founded FTX in 2019. Two years earlier, he started a crypto trading firm called Alameda Research, and his dissatisfaction with the quality of existing crypto exchanges inspired him to try to build a better one. 

FTX’s big funding boost started in summer 2021, when it raised the first of three successive rounds of funding at increasingly high valuations. Within seven months, it raised $1.9 billion from more than 70 investors, according to data provider PitchBook. 

The investments were notable for their structure. Multiple investment rounds were split widely among dozens of funders, a contrast to typical venture-capital rounds that have one lead investor that negotiates key terms with the company, several investors said. 

The lack of a lead investor strengthened FTX’s negotiating position, and made it harder for venture investors to argue for a board seat, those investors said.

What got many investors who heard the pitch comfortable was FTX’s supposed simplicity. While the crypto sector is full of companies with difficult-to-understand business models that rely on speculative tokens for growth, venture investors in FTX boasted that it was merely an exchange that made real money by taking a cut of crypto transactions.

“We’re not really speculating on whether prices of crypto assets, Bitcoin or otherwise, are going up or down,” the Ontario Teachers’ chief investment officer,

Ziad Hindo,

said at the fund’s annual meeting in April, according to a transcript. The bet, he added, was that “there will be a lot more transactions, and clearly, exchanges benefit.”

Ontario Teachers’ said in a statement posted on its website on Thursday that any financial loss on its FTX investment would have a limited impact because it represents less than 0.05% of total net assets. “Naturally, not all of the investments in this early-stage asset class perform to expectations,” the fund added.

Venture-capital-backed startups typically have a board that includes at least one or two early investors. Those putting up large sums of money often negotiate a seat to help oversee the company. But until summer 2021, the sole director was Mr. Bankman-Fried, according to securities filings and people familiar with the matter. 

As part of a summer 2021 funding round in which FTX raised about $1 billion, the company told investors in a letter that it would add two “highly qualified, independent” directors to the board. 

By the next funding round those directors were in place. FTX appointed Jonathan Cheesman, then an FTX executive, and Arthur Thomas, a lawyer in Antigua whose website lists gaming as his specialty. Mr. Cheesman was succeeded by another FTX employee earlier this year.

For U.S.-listed public companies, independent directors aren’t permitted to be executives or have other financial relationships with the companies.  FTX is closely held and based in the Bahamas. 

Mr. Bankman-Fried told the Financial Times in March, which reported on the makeup of the three-person board, that a board should “reflect what is important for the company’s operations and oversight rather than monetary contributions.” 

One reason venture investors like to sit on boards is because directors typically have to approve related party transactions, in which the company does deals with its top executives or large shareholders. 

Related party transactions are at the heart of FTX’s troubles, especially billions of dollars of flows between FTX and Alameda Research, a crypto trading company also controlled by Mr. Bankman-Fried, The Wall Street Journal reported. A CoinDesk article about those links helped spark a wave of withdrawals at FTX that led to its current crisis. 

In its most recent audited financial statements for 2021, FTX disclosed that related parties accounted for around 6% of total transaction volume, according to several people familiar with the matter. No significant loan exposure to Alameda Research was specifically mentioned.

After cryptocurrency prices plunged earlier this year, FTX was seen as a rare bright spot among venture capitalists, who saw Mr. Bankman-Fried as a prudent risk manager who was quickly emerging as a leading voice in the industry. 

Until earlier this week, FTX had a prominent place on Sequoia’s website, listed as the fourth startup featured atop its page. An article gave an inside look at the firm’s partners’ reactions to meeting Mr. Bankman-Fried, including an internal message from an unnamed Sequoia partner who wrote, “I LOVE THIS FOUNDER.”

Some investors viewed Mr. Bankman-Fried’s Alameda experience as a plus, given he built a large, profitable business with little outside investment. 

After its investment in FTX last year, Samsung Next, the venture unit of the South Korean conglomerate, noted his role in building Alameda before starting FTX in a blog post about its investment. The post described Mr. Bankman-Fried as a “crypto wunderkind” and called the company “One of the hottest startups in the world.” 

Write to Eliot Brown at [email protected], Peter Rudegeair at [email protected] and Berber Jin at [email protected]