Why investors keep falling for child prodigies

Time and again, investors are fooled by charismatic founders, most recently in the case of the crypto exchange FTX. Why does this scam work again and again? An attempt at an explanation.

It was a really exciting economic drama that played out in the crypto world over the past few days. FTX, one of the largest crypto exchanges in the world, collapsed in a very short time. Reports quickly made the rounds about the freehand handling of customer deposits, about an overstretched management team that consisted mainly of friends of the company's CEO Sam Bankman-Fried. There are also allegations of fraud. It can be assumed that Netflix is already putting a documentary crew in place to shed light on the disaster in its entirety. 10 episodes of 45 minutes each, probably coming soon.

As amusing as the whole thing is to watch, the FTX collapse also points to a fundamental problem that manifests itself particularly in the tech industry. This is not about the dark sides of the crypto market, which are once again evident here. It's about the tendency to be blinded by alleged prodigies and geniuses - and that harms the entire scene enormously.

Few industries practice such a cult of personality around company founders. Sometimes this is justified. Steve Jobs, Mark Zuckerberg or Elon Musk may be (or have been) controversial, but their success usually proved them right. But time and again, it also becomes apparent that there is little substance behind the big show and messianic posturing.

Take Theranos, for example: the young founder Elizabeth Holmes posed as a female biotech Steve Jobs, right down to her black turtleneck sweater. She received 700 million US dollars for her start-up, which supposedly developed revolutionary blood tests. None of it was true; Holmes was convicted earlier this year.

Cue Wework: The charismatic Adam Neumann promised to turn the coworking company into a kind of comprehensive lifestyle brand. At the beginning of 2019, investors thought it was a $47 billion idea. Less than a year later, lead investor Softbank paid Neumann $1.7 billion to pull out of his own company as completely as possible. The founder's behavior, both at the company and in his private life, had become so problematic that Wework's continued existence was on the line. At least, unlike Theranos, the company still exists, but it is not making money to this day.

So now Sam Bankman-Fried, SBF for short, because in the crypto scene you apparently don't have names, only acronyms. There was a lot of enthusiasm for the son of a lawyer from Stanford, who had not only built up a huge platform, but also appeared altruistic and modest. He allegedly continued to drive an old Toyota Corolla despite his 20 billion dollar fortune. That this image was so far from the truth has become clear in recent days. SBF will now go down in history at least as an overachieving frothing-at-the-mouth, should some allegations be substantiated, probably even as the crypto Bernie Madoff.

Why do people who manage and invest money professionally fall for the apparently same scam again and again? Research provides a clear answer here: we humans tend to look not for the best leaders, but for the most charismatic ones, superheroes in a sense. The female Steve Jobs, the co-working Jesus, the big-hearted crypto-bro: all of these fit this pattern. But unfortunately, charisma often brings with it a dark side. It's often narcissists and sociopaths who seem particularly charismatic to us, thanks to their self-assured demeanor and daring moves. Only these people often care precious little about what happens when they miss the mark. This pattern has worked for centuries, in politics, in entertainment, in business.

It's not at all surprising that the tech industry, of all places, has a concentration of such cases. The answer here is probably even simpler: many people simply don't understand the subject matter. Biotechnology is complex, the blockchain and crypto world is a jungle full of terms and technologies that hardly anyone understands. And coworking is not complicated, but when a long-haired, charming Israeli blathered on about the We Company, which is supposed to encompass all areas of life, some people nodded knowingly instead of admitting that they had no idea what the gobbledygook was supposed to mean. This is not only true for amateurs and private investors, but frighteningly often also for professional investors, VCs and so on.

By the way, no one should be fooled by the fact that these examples all come from the USA. We Germans also like to fall for such types. Here, we can only refer to Markus Braun and his company Wirecard, which fits perfectly into this series. A supposed guru - who also liked to unpack his black Jobs turtleneck - a technology that hardly anyone understood, and in the end, sums of billions were burned and a lot of supposedly smart professional investors looked pretty stupid.

So what to do? Funders need to take a closer look. In all the cases described, irregularities were visible long before the big bang, if you only looked properly. With a little due diligence, you can avoid such problems. But it is at least as important to resist the herd instinct from time to time. When the large herd of cattle once again stampedes in one direction, in a dynamic that, in retrospect, it often cannot explain itself, it is worthwhile to simply not run with it.

Will the latest case lead to this rethinking? Perhaps yes. Probably no. Wework founder Adam Neumann, for example, recently received another $350 million for a new start-up. To what extent this can be reconciled with a learning effect on the part of investors is very questionable.