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Fabulous Startup or Fraud? Can you spot the fraud?


There’s a cautionary tale being played out in the courts on a startup that raised $1.4 billion over 13 years or so. Founded in 2003 by 19-year-old Stanford University dropout, Elizabeth Holmes, Theranos quickly attracted backing from people like US Treasury Secretary George Schultz, media magnate Rupert Murdoch, former Secretary of State Henry Kissinger, and the Waltons (Wal-Mart),  just to name a few. At 1.4 billion, there were a lot of wealthy investors who got duped.

Elizabeth Holmes was said to be the world’s youngest self-made female billionaire in 2015 when she shared a stage with former President Clinton at his Clinton Global Initiative Annual Meeting.

Theranos, a name derived from the combination of words therapy and diagnosis, was built to take a blood testing product to market. Heavy buy-in and funding put the Theranos blood analysis machine in 40 Walgreens stores in Arizona, with plans to place them in every location eventually.

What went wrong with this company? What was overlooked by some very high powered influencers who invested in it?  What mistakes did they make that were foreseeable and preventable that we can learn from?

Any time someone puts their money at risk in any investment, they should be checking themselves against their own basic investing rules. As an angel investor, this means attention given to financials, founders and key investors.  Most of all, there has to be a minimum viable product.

Hindsight 20/20 Diagnosis

The Theranos’ alleged fraud story broke in The Wall Street Journal in October, 2015. Ironically, the Wall Street Journal is owned by one of Theranos’ key investors, Rupert Murdock. At the time the story broke, he was actively giving millions of dollars in investment capital to Theranos, yet he didn’t try to quash the story even though it was requested by Holmes and Sunny Balwani, Ms. Holmes’ live-in boyfriend and chief operating officer of Theranos.

This was TWO years ahead of Theranos pulling in $700 Million from investors. The information was out there to find. The fact that they didn’t was akin to watching an emperor walking down the street in his “new clothes” and not seeing what was there!

MVP – minimum viable product is where everything about Theranos pivots to fraud. The last $700 Million raised by Theranos was influenced by Walgreens announcing that they were putting machines in their stores, with Theranos’ board of directors and key inventors not knowing that Theranos was using existing market analytic machines to create results. And since there was not sufficient blood for those machines to accurately analyze, results were wildly off and inconsistent.

Board of Directors, Executive Team – a treasury secretary and former secretary of state, a retired Navy general and retired US Marine Corps general, former secretary of defense and a former senator – do you notice what’s missing here?

What did any of them know about biochemistry? Would they even know the questions to ask in order to verify for themselves that nothing was amiss. Elizabeth Holmes didn’t have the rigorous training in biochemistry. Many startups actually partner with their respective universities for such expertise and Stanford is well known for their involvement in medical technology startups. While Ms. Holmes was mentored by a professor, it’s not the same as direct involvement and oversight.

There was also no chief financial officer for most of the lifespan of the company. Henry Mosley was the last chief financial officer, and he was fired by Holmes in November, 2006 for questioning the reliability of the lab testing systems and equipment. [source: CTM File]

On one hand, not having the biochemistry and engineering expertise in leadership  inhibited the development of a legitimate product, but on the other side, these missing experts at the table meant that Elizabeth Holmes and Sunny Balwani were not challenged or questioned and their fraud was unfettered by these uncomfortable oversights. This lack of depth in the skillset of the company leadership is one of the reasons charisma won over deep analysis.

Research Rigor, Regulatory Compliance and Transparency – Former Theranos employees who became whistleblowers discussed the tampering and cherry-picking of data, or deleting failed experiments in the R&D labs at a Stanford University symposium discussing the faulty model being used, or not using Theranos technology. [source: Stanford University]

Theranos stepped into the administrative gap between the FDA which governs pathway to market for many medical technologies, and the CMS or Centers for Medicare and Medicaid Services which certifies laboratories. By classifying its nanocontainer blood collecting technology and deficiencies in documentation, Theranos was able to elude oversight until 2015 after the Wall Street Journal story broke. Both FDA and CMS then cited Theranos and revoked certifications. [source: ACCP]

Show me the money!  Elizabeth Holmes and Sunny Balwani told investors that Theranos had generated or would generate over $100 million in revenues in 2014. But in reality the company had not generated much more than $100,000. In 2015, Holmes actually provided a potential investor financial results for fiscal year 2014 that showed net revenues of $108 million with projections for 2015 and 2016 of $240 million and $750 million respectively. [source: SEC]

Due Diligence

As I look through all of the buzz around the upcoming trial, “due diligence” was the key opportunity EVERY investor and key player overlooked. Can we assume that since these were notable venture firms, savvy individuals and profit-motivated companies which failed to perform this task, that we are also fallible to miss information that is right there in front of us when we hear a charismatic pitch or feel our pulse race as we look at an opportunity that meets a huge societal need?  It’s called “chasing unicorns.” It’s an emotional hijack that we can and must  prevent impacting our decisions with constant vigilance to due diligence.

I would endorse constant vigilance to due diligence as your top priority as an investor or as a new hire working for a startup at a lower wage in exchange for a share of the company.

Chasing Unicorns

There is a huge tendency when evaluating a startup opportunity to overlook due diligence in the quest to find the next unicorn. While we use examples of “what if ” when we talk about angel investing such as Amazon or Facebook and other phenomenal startup unicorns, the reality is that most startups fail. When we are driven by fear of missing out on finding such a unicorn, or driven by blind hope, we make costly mistakes.

FOMO is particularly expensive and very likely what drove highly credible names to buy-in to Theranos and Elizabeth Holmes. Think back to your last stock pick or startup that lost you a lot of money? Have you considered the emotions that drove you to invest as you did?

FOMO drove Walgreens to accept that their laboratory expert, Kevin Hunter, was prevented or blocked by Theranos from being able to perform his job; to verify the validity of the technology. And yet, they still pursued the deal. Red flags EVERYWHERE here!! Even doing their own side-by-side testing when the technology was placed in one of their stores in Palo Alto wasn’t allowed. The fear that Holmes would take the partnership offer to their major competitor, CVS, drove them to ignore the lack of valid clinical data.

Hopium – the emotional drive that blinds investors came into play in this case with the idea that it was possible to derive all of the necessary health data from a single finger prick rather than vials and vials of blood. It’s devastating to watch small children or elderly patients endure blood draws, especially when cancer ravages the veins in the arms, back of the hands and other places.

It wasn’t just the hope of getting in on a start up that could revolutionize the way we use blood data – and the amount of growth such an invention and the company driving that invention would experience. Usually there’s a healthy amount of greed that drives angel investing that has to be balanced and harnessed by due diligence and skepticism.

But when unchecked investment ambition meets a solution for the experience of medical torture (needles), hope can blind investors and corporations.

Conclusion: Legal Dust not Settled

As jury selection and trial proceeds against Ms. Holmes, the education and remaining chapters in this cautionary tale for angel investors will roll out the consequences for Ms. Holmes, as well as the principle players who lent their credibility and influence and money. I haven’t even talked about the detriment to the patients who had additional costs for verification blood testing.

The case for Mr. Balwani will begin in January, 2022.

But the conclusions we can reach for ourselves as we pursue our next investment opportunity will be punctuated by the need for due diligence and attention to MVP, financials, principals – who is at the table and who should be, and keeping a tight leash on our emotions. As always, diversification of assets across several opportunities is imperative.