In the volatile world of startups, stories can change swiftly. Two years ago, IRL, a promising messaging app startup, basked in its “unicorn” status, attaining a staggering $1.2 billion valuation through a successful Series C funding round led by SoftBank Vision Fund 2. But today, the startup finds itself embroiled in a $150 million lawsuit from SoftBank, a drastic turn of events that underscores the importance of robust due diligence in the venture capital landscape.
Unveiling the Deception
IRL had once projected ambitious aspirations, aiming to be a global equivalent of China’s WeChat, a messaging app with over a billion users. However, the rosy picture painted by the startup began to unravel when SoftBank accused IRL of inflating its user base with fake accounts and bots. The lawsuit alleges that 95% of IRL’s reported users were inauthentic. SoftBank contends that IRL employed a proxy service to amplify user data and even enlisted external help to mask this deception.
Valuation, Metrics, and Due Diligence
SoftBank’s lawsuit highlights the critical role that metrics play in determining a startup’s value to investors. As IRL lacked a profitable revenue stream, its user metrics held substantial weight in attracting external investment. SoftBank contends that its decision to invest was heavily influenced by IRL’s reported user figures, which later turned out to be significantly inflated.
The incident underscores the importance of due diligence in the investment process. Venture capitalists emphasize the need for thorough assessment beyond the company’s own representations. References from sources independent of the startup can provide a clearer perspective. David Sacks of Craft Ventures emphasizes the significance of talking to customers and evaluating off-sheet references, while Chamath Palihapitiya points to the need for rigorous checks and balances and experienced VCs who can ask the tough questions.
Lessons Learned and Unfortunate Consequences
As SoftBank grapples with the aftermath of the IRL debacle, the company’s record investment losses of nearly $40 billion in its tech-focused Vision funds cast a shadow over its operations. The situation also led SoftBank to adopt a defensive stance, putting a halt to new investments by its funds.
The IRL case serves as a sobering reminder of the complexities and potential pitfalls in the startup investment landscape. It underlines the need for investors to approach with a discerning eye, relying not solely on data provided by the startups but conducting thorough due diligence to ensure the accuracy and authenticity of the information. In an industry where valuations can rise to astronomical heights, the case of IRL serves as a cautionary tale of the perils of unchecked optimism and the importance of meticulous evaluation.