This Article examines venture capital (“VC”) due diligence practices in the wake of FTX’s collapse and a broader rise in startup fraud. It introduces the “due diligence dilemma”: a core tension between the imperative to invest rapidly and the widespread, yet often unfulfilled, expectation that VC firms serve as effective gatekeepers through independent diligence. The Article argues that this dilemma is exacerbated by cyclical market conditions, which give rise to a collective action problem. Individual VC firms are incentivized to expedite investments and rely on others’ diligence efforts in order to maintain a founder-friendly reputation. The result is “proxy due diligence”—a practice of inferring trustworthiness from the presence of other reputable investors rather than conducting independent verification. While this approach may be rational for VC firms and their limited partners, who can hedge against failure through portfolio diversification, it can result in real harms to employees, customers, and other stakeholders who treat VC investment as a proxy for reliability. This Article suggests that the current legal framework, which primarily depends on private ordering between sophisticated private parties, may not adequately address these wider implications.
This Article explores potential legal and regulatory responses, ranging from enforcement actions to more prescriptive due diligence requirements, and concludes by addressing the fundamental question underlying this discussion: Are the potential impacts on uninvolved parties simply an unavoidable trade-off for innovation-driven economic growth, or might carefully designed policy interventions encourage VC firms to consider the wider social implications of their investment and oversight decisions?
* Yifat Aran is an Assistant Professor of Law, University of Haifa Faculty of Law.
** Nizan Geslevich Packin is a Professor of Law at Baruch College, CUNY, and at the University of Haifa Faculty of Law, and is an ECGI Academic Researcher. We thank the participants of the Tech, Innovations, Banking, and the Future of Venture Capital in Silicon Valley Symposium at the University of Illinois College of Law on March 29, 2024, the 25th Annual Law & Business Conference at Vanderbilt Law School 2025, the 2025 ComplianceNet Conference at Fordham Law School, and the participants of the Ono-Columbia 15th Annual Conference on Corporate Law & Governance for helpful comments. This research was supported by the ISRAEL SCIENCE FOUNDATION (grant No. 396/23). Special thanks to Abby Milhiser and the University of Illinois Law Review editorial team for their thoughtful guidance and dedicated editorial efforts. Finally, a special thanks to Joe Grundfest for a correspondence that inspired this project.
The full text of this Symposium is available to download as a PDF.