A new mass-fraud scheme is hitting the half-trillion-dollar VC industry, expert says. How to detect and prevent

New mass-fraud scheme is hitting the VC industry. One of the best-known venture experts in Ukraine, investor and entrepreneur Denis Dovgopoliy, on his LinkedIn page, has revealed what are now informally called “gray” and “black” schemes and are already popular in the US and Western Europe but only starting to hit in Ukraine and neighboring countries. 

He also named three old ones that were popular back in the 2000s. AIN.UA shares his insights.

Ye olde schemes

Back in 2005, when Dovgopoliy came to the industry, there were only three main types of scammers, he says.

  1. Scammers who tried to sell a non-existent startup or a startup with a non-existent product, but the existing methodologies du jour cut off most such attempts.
  2. Pseudo investors sent startups for overpriced audits to a related auditing company. Understandably, after such an audit, a negative decision was made about the investment.
  3. Raiding companies and using startups and venture capital firms to launder criminally obtained money. 

“Over the years, the industry has adopted these risks. Entrepreneurs and investors who understand the rules of the game have learned to mitigate such risks. But new times call for new solutions,” says Denis Dovgopoliy.

New mass-fraud scheme is hitting the VC industry

Entrepreneurs and consultants who helped funds do the due diligence and raise money for startups (one of those are Denis himself) encountered a new kind of fraud that split into two independent lines — they called them “gray” and “black” schemes.

Details of the Gray scheme

The startup pays for a consulting or advertising contract, which, minus a commission, it begins to receive in the form of revenue. Thus, the conditional $50,000 returns in the form of $30,000-$40,000 ARR multiplied at round A industry multiplier (7-15x). That means, for the $50,000-$100,000 startup can get an additional $1 million in valuation. That said, the execs know how to manage the churn of the project.

This scheme works for both b2b and b2c startups with checks from $20 to $100 for a monthly or annual payment.

“The case is an apparent fraud on the investor who determines or confirms the startup’s valuation at the investment round. We found a company that tried to add +$4M to their valuation this way,” says Dovgopoliy.

Details of the Black scheme

The second scheme is more unpleasant. It implies that for $50,000, you can get up to $300,000 in such proceeds, but then the money will come in either from stolen cards or cards from risky countries. 

“Such a scheme falls ultimately under AML law and is 100% criminal. It can be determined by having access to the startup’s billing during due diligence,” says Dovgopoliy. 

How to detect the scheme

Both schemes can be detected by picking out the cluster of paying clients who do not use the service at all – scammers can easily automate the creation of new accounts, payments, including recurring ones. Still, they cannot imitate the usage of the startup’s product at the moment. Moreover, the second scheme sometimes has a high payback request. 

“We managed to find more than 20 startups that have suspicious signs in two months. There are checks on them, and even two forensics goes,” Dovgopoliy shares. “At the moment, we have already managed to find two independent contractors for such schemes.”

Experts are now trying to understand the scale of this kind of fraud on the market. It is yet unclear what damage those schemes have already done.