I recently read Bad Blood, a great book about the rise and fall of Theranos, a venture-funded company that was once a darling of the tech world. The company claimed to have invented technology that could perform a wide range of blood tests with only a single drop of blood. The company raised a whopping $700 Million from venture capitalists and private investors and, at its peak, was valued at as much as $10 Billion. Today, the company has ceased operations and its founder, Elizabeth Holmes faces trial for fraud, along with Theranos’ president, Sunny Balwani.
As I read the book, what struck me as most stunning is how the founders managed to raise so much money without ever offering any proof or third-party validations that the technology worked at all. The on-site demonstrations that the company performed were smoke and mirrors and the demonstrators never actually showed that the tech worked–because it really didn’t. And yet, the company managed to raise enormous sums of money as a result of extravagant claims. Holmes claimed that the technology was in on-site testing by the military, and nobody ever checked this was actually true, for example.
In reading the book, several things really stand out as big red flags for investors. First, the lack of any third-party validations or testing. Second, the fact that most investors were confident that those who had already invested money had done the necessary due diligence. In other words, if Joe invested, that’s good enough for me because Joe is really savvy. Third, the company’s board of directors was comprised of people who were well-connected but lacked any background in biotech or technology of any kind. Board members included Henry Kissinger and George Shultz, both former Secretaries of State, a former Secretary of Defense, and two ex-senators.
As I read the book, I kept thinking that the situation was remarkably similar to Bernie Madoff’s decades-long fraud, which was ultimately revealed to be a $65 Billion Ponzi scheme. Madoff claimed to have an amazing proprietary trading method that generated high returns with little risk. His trading records were entirely falsified. Both individual investors and institutional money managers invested enormous sums of money with Madoff with no significant due diligence. People invested because they heard that big names had invested with Madoff. Madoff was also politically well-connected, with friends at the highest levels of government and even the SEC.
So, ultimately the lesson from Theranos is to be very wary of promises of a remarkable new opportunity, technology or formula until there is a legitimate validation of the results. Even when other smart people get on board, be skeptical of anything that sounds too good to be true. This sounds obvious, but there are many cases in which sophisticated and experienced investors are taken in. While Theranos (and Madoff) are two of the biggest and best-known recent cases, there are many more (Enron, for example). People often let the promise of a big score overwhelm reason.
Geoff Considine on Finance and Economics 