A lot of people are shocked that an esteemed firm like Ignition Partners might have been hoodwinked by the former executives of Seattle-based Entellium, which attracted a whopping $50 million in funding on apparently falsified revenue numbers.
Ignition isn’t talking about the continuing due diligence it should have conducted and clearly didn’t. Neither are Entellium’s other investors, Sigma Partners, Intel Capital, WestRiver Capital, and Malaysia Venture Capital Management. (I’ve tried to speak with several of the investor board members; none is responding to requests for comment.)
But Entellium’s venture backers may not have been the only ones who were snowed. What about Silicon Valley Bank, which carried multiple millions of dollars of debt for Entellium and, according to a source at the company, reviewed Entellium’s books quarterly, on site, for three years?
And what about Cascadia Capital, which represented Entellium during some of its successful fundraising efforts and that, according to the same company source, was introducing Entellium to new venture investors as recently as one month ago?
SVB and Cascadia have not responded to requests for comment left early this morning. However, I just spoke with James Montgomery, the head of Montgomery & Co., whose bank was nearly entangled in the whole mess. It was introduced to Entellium last summer and was beginning its due diligence process when the alleged fraud was surfaced last month by the company itself.
“Like everyone else,” said Montgomery, “we were shocked and disappointed and terminated our relationship with [Entellium] as soon as the revelations were made.”
While we were on the phone, I asked Montgomery what his bank’s due diligence process consists of. As a matter of course, he told me, it conducts a background check on a potential client, calls references and customers, and looks at a company’s audited financials. “It takes us longer to do a deal than have a baby,” he said.
Steve Fletcher, a managing director at San Francisco-based GCA Savvian, told me in a phone call afterward that Savvian operates much the same way. “First steps are you understand the business from an outside perspective before you take anything on — you understand the space, and you talk to other people in the business about the company.” Afterward, “you spend a couple of days at the front end, understanding the business and financials,” then start talking to the company’s customers and auditors, he said.
It seems more likely than not that Cascadia skipped a step or two in the normal process of things. Still, observers, including Fletcher, say what happened at Entellium could happen to nearly anyone. “If a company’s executives are really set out to defraud people,” he said, “if they make up invoices or clients, as an auditor or a board member or an investment banker, it’s difficult to detect.”
Though a bank works for the board and talks to the company’s auditors, “the board members aren’t knee deep in the numbers,” said Fletcher. “The CEO and CFO are the most important executives of company. In reality, most of your information comes from them.”
“Can you totally prevent something like this? You can’t,” adds attorney Carl Metzger, who concentrates on business litigation for tech companies at the firm Goodwin Proctor. “With thorough due diligence, you can mimize the risk, but there’s always the possibility of fraud when you’re engaged in business dealings with other people.”
For example, Silicon Valley Bank probably was looking at the real books, suggests the CFO of a Silicon Valley venture capital firm who asked not to be named. “But the CEO and CFO were going into board meetings and telling their investors a completely different story.”
Apparently, an audit — which Entellium, like many startups, doesn’t appear to have undergone — might not have made a difference. “That information would have probably gone into a circular file somewhere,” said the CFO. “We get these audited statements and I don’t think anyone looks to compare them to see if things match up.”
The problem with Entellium, he said, “simple damn fraud” that went on and on, happened because no one — not its investors or lenders or investment bankers — appears to have done enough due diligence. “If they’d talked to anyone other than the CEO and CFO at the heart of this case, this situation might have ended a lot time ago, or not happened in the first place. It looks like everyone was asleep at the wheel.”