Startup bragging and exaggeration rights

It seems to be common knowledge that startups like to exaggerate their results when they talk to the media. While I’ve known this for a long time, I was rather startled to see the numbers put out by a company I know, which seems to be an order of magnitude larger than what is actually the case. And when I was discussing with someone else in the know, I was told that this degree of overstating (especially to the media) is a common thing in the startup world.

In “normal” companies, overstatement of numbers is a massive crime, and shareholders can prosecute the management for such activities. Yet, it seems like investors in startups (funded startups seem to do this all the time) don’t seem to mind this at all. What is the difference?

“Normal” steady-state companies usually don’t have to raise capital too often. After they’ve raised a certain amount, hit steady state and gone public, raising more capital is a rare event. Also that they are public means that you have “gullible households” who own equity, and investor protection laws mean that they need to state incomes and other financial information to the best of their knowledge, and any cooking of the books can lead to prosecution.

For a startup, on the other hand, raising capital is a “normal” (as opposed to “extraordinary”) event, and its investors are mostly sophisticated investors (apart from gullible employees who have been forced to take equity for “skin in the game”). By overstating its numbers, especially in the popular media (hopefully now with the Registrar of Companies), startups can hope to create greater buzz which increases the likelihood of getting a next round of investment at a higher valuation.

Notice that in this case investors are also okay with the books having been cooked since they aren’t playing the dividend game but have a short term goal of raising more funds at higher valuations. And if overstating numbers can help that, so be it!

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