A contract with a tech giant can put a startup on the map with venture capitalists and the market at large. That’s what happened for Netskope, a cloud-based data security provider. Founded in 2012, the company was able to quickly scale up and secure multiple rounds of funding — in part because it had a top-tier customer right out of the gate: Netflix.
There was just one catch to landing that deal: It had to hire the streaming company’s vice president of IT operations, Michael Kail, as a consultant and an advisor, and pay him with fees and stock options. Netskope (not to be confused with the now-defunct Netscape) wasn’t the only startup confronted with that proposition. At least nine firms that worked for Netflix entered into similar arrangements, according to the U.S. Justice Department.
Other companies drawn into Kail’s web included software, cloud-storage and analytics companies Docurated, Numerify, NetEnrich, Platfora, VistaraIT, ElasticBox, Maginatics and Sumo Logic.
The shady-sounding plot was described by the government during a criminal trial earlier this year in San Jose federal court. Kail was found guilty of more than two dozen fraud and money laundering counts. At his sentencing now set for Nov. 15 [previously scheduled for Oct. 19], prosecutors will ask that he get a stiff punishment of seven years in prison as well as be ordered to pay fines, restitution, and forfeit a $3.3 million home in Los Gatos, California.
The former Netflix VP, who also briefly served as chief information officer at Yahoo, “leveraged his status as a leader of the IT community in Silicon Valley to subvert the trust of Netflix and others to profit at their expense,” prosecutors said in a recent court filing. They added that the similar schemes are “almost certainly” common among high-level tech executives, but that in no way excuses the behavior.
“The startups that paid to play, and possibly many others, believed this was how Netflix did business,” the prosecutors said.
A disturbing element of this narrative is the unequal playing field startups are on when they negotiate with big companies. As the government suggested, the crimes also seem relatively easy for an influential executive to carry out — especially since the founders of fledgling firms have little if any incentive to blow the whistle, and may feel they have no choice but to go along with a pay-to-play scheme.
In his own memorandum to the court, requesting that he be sentenced to a year of house arrest, Kail, 49, described himself as a “global power leader, top dev ops influencer and a thought leader.” He appeared to minimize the impact of the crimes, describing them as “regrettable flaws in communication and transparency,” and asserting that his undisclosed business relationships were more helpful than harmful to all involved.
Yet many startup founders already have ample complaints about overly-generous advisor compensation and messy cap tables, even without the added corporate bribery wrinkle. Earlier this year, Reddit co-founder Alexis Ohanian brought attention to a company called Cabal, which aimed to help founders allocate shares more judiciously and cut down on “dead equity” handed out to mentors, friends and consultants.
Startups are also at a distinct disadvantage in negotiations with established firms, and may fall prey to diresputible tactics, according to research published in 2018 in Harvard Business Review. The researchers recruited 250 experienced purchasing and sales managers and asked them to carry out a negotiation scenario as either buyers or sellers. The participants who were told their counterparty was a startup, rather than a mature firm, were significantly more likely to use deception, according to the researchers.
“Startups rightly face increased scrutiny when negotiating with partners because of their perceived ‘fake-it-till-you-make it ethos,’” the researchers wrote, referencing high-profile scandals such as the fraud involving blood-testing firm Theranos. “But our research suggests that, if there is to be fraud during a negotiation, it is new companies that are more likely to be the mark — and they should take steps to safeguard themselves accordingly.”
Luckily, for the tech firms ensnared in Kail’s wrongdoing, damage was relatively limited, and some like Netskope may have even benefitted from the fraud. Other companies in similar circumstances might not end up unscathed.