In the world of startups, founders are often elevated to near mythical status – the force poised to disrupt entire industries. This adulation can grant founders extraordinary latitude in corporate control, especially in innovative and unregulated sectors like tech or crypto. However, when this reverence turns into “founder worship,” especially under the guise of doing good, it blinds investors and stakeholders to the absence of basic corporate governance. The consequences can be disastrous. The rise and fall of FTX and its founder Sam Bankman-Fried (“SBF”) offer a cautionary tale – one where charisma, weak governance, and the veneer of altruism obscured its lack of corporate discipline. It is a stark illustration of what can happen when governance norms are subordinated to a visionary founder.

At the heart of the FTX scandal lies a troubling paradox: The “do-gooderism” that made SBF a household name and the darling of the venture capital world also amplified founder exceptionalism and deferred governance in the name of innovation. In essence, FTX highlights the dangerous interplay between founder worship and a specific kind of moral narrative that led to a company operating without fundamental corporate safeguards and meaningful checks on the founder’s authority.

The Legal Risks of a Mission-Driven Founder

The rise of effective altruism (“EA”), a philosophical and social movement that emphasizes evidence-based philanthropy and the strategic use of wealth to maximize social good, permeates elite universities and the tech ecosystem. SBF’s association with EA lent him credibility and moral capital, particularly among sophisticated investors like Sequoia Capital, BlackRock, and Thoma Bravo LP. In theory, EA is aligned with ethical principles – encouraging rich individuals to donate substantial portions of their income to causes that yield the greatest impact.

The reality, however, was that EA served as a moral halo for SBF, evidence of his integrity and commitment to the greater good.  SBF’s disheveled appearance reinforced the impression that he was intensely focused on building the first one trillion-dollar startup solely for EA goals. This impression created trust in SBF, which substituted for governance. FTX’s legitimacy was bolstered not by its compliance with best practices but by its founder’s supposed noblesse oblige, which was based on his commitment to EA.

Private Ordering and the Startup Governance Gap

Venture capital-backed startups operate in a unique legal environment where private ordering allows early-stage companies to structure governance, allocate rights, and implement oversight according to their own preferences. The flexibility accorded to private companies contrasts with the discipline expected of public companies, where ownership and control are clearly separated and heavily regulated.

In many ways, this flexibility allows startups to move fast, take risks, and innovate. Over time, oversight mechanisms such as investor board seats, staged financings, and protective provisions typically create checks. However, when a founder commands cultural and financial capital, as did SBF, these checks may be non-existent. Enamored by mission-driven founders, investors sometimes abdicate their responsibility to control and manage the startups through the board of directors and to vote on corporate policies. The promise of massive returns can distract the most seasoned venture capitalists to the extent that they ignore red flags.

By deferring or waiving such checks, a company whose corporate governance is based on private ordering can falter or even collapse. In the case of FTX, a founder-centric structure, coupled with mythical “do gooderism,” became a shield against scrutiny and ultimately led to the company’s demise  and SBF’s criminal conviction.

FTX: A Case Study in Corporate Governance Failure

FTX was not subject to even the most basic corporate controls. Financial audits, effective board oversight, and internal compliance mechanisms were absent. Investors overlooked these red flags based on SBF’s visionary status and mission-driven narrative.

The failure was structural. Although there is nothing inherently wrong with believing in a founder’s mission, the law must be agnostic to motives, and governance safeguards must be applied at the appropriate times. As FTX shows, private ordering has its natural limits. Faith in founders is no substitute for the timely implementation of legal guardrails to ensure startups do not engage in crime or fraud. By cloaking SBF in moral credibility, he was allowed to operate with little to no constraints, which ultimately led to the implosion of FTX.

A Path Forward: Rebalancing Private Ordering with Guardrails

To prevent the next FTX, we should tighten the boundaries of private ordering. There are several reforms worth considering:

1. Early Adoption of Governance Standards: Basic governance mechanisms should be instituted earlier in a startup’s life. Investors should be extremely cautious about abandoning basic governance when they make investments in new technologies infused with hype and headed by self-promoting, visionary founders.
2. Ethics Codes for Startups: A startup-specific code of ethics can signal commitment to legal and ethical norms from the outset, beyond the founder’s personal values.
3. Stronger VC Due Diligence: Venture capital firms and their legal advisers should more critically examine founder control and mission-driven startups. Deference to strong founders as leaders of disruptive startups should not prompt less-than-thorough due diligence.
4. Avoiding Novel Board Structures: Traditional board structures work; sidelining or delaying oversight in the name of innovation must be avoided.
5. Regulatory Compliance in High-Risk Sectors: In sectors with high regulatory risks, startups should treat compliance as a competitive advantage.

Conclusion

It is tempting to dismiss FTX and SBF as anomalies in an otherwise functional private ordering system. But the conditions that enabled FTX’s meteoric rise and precipitous fall are embedded in the culture of venture-backed startups where there is a bias toward disruption over discipline.

Startups cannot be allowed to circumvent legal norms just because they are mission-driven. Founder worship should not override the legal structures that protect investors, employees, and the public. The FTX saga underscores that private ordering has limits. Ultimately, its success depends on the timely implementation of corporate governance measures to ensure legal accountability.

This post comes to us from Jennifer S. Fan, the Therese Maynard Chair in Business Law at LMU Loyola Law School, Los Angeles and affiliate professor at LMU’s College of Business Administration, and Xuan-Thao Nguyen, Pendleton Miller Chair in Law and the Director of the Asian Law Center at the University of Washington School of Law. It is based on their recent article, “Founder Worship, Effective Altruism, and Corporate Governance,” available here.