Theranos and the logic of start-up betting

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This article is part of the On Tech newsletter. Here is a collection of past columns.

Elizabeth Holmes, founder of the failed blood testing start-up Theranos, is nearing the end of a criminal trial to decide whether she intentionally misled investors in her business, as well as patients and doctors.

A central issue in the case is the line between fraud and “pretend until you do” ethics in Silicon Valley. Theranos also feels like an extreme result of a financial system that often rewards throwing money blindly in the search for the winning startup lottery ticket.

Start-up investors pride themselves on finding promising young companies, but their work is a kind of crapshoot. Any investment is very lucky. But supporting young companies is essentially a gamble that a few wins can make up for a lot of lemons. Start-up investors, in theory, can lose all of their money 99 times out of 100, and they’re in gold if one of them is the next Google.

This early stage venture capital system was, until recently, a small corner of finance, but it has a disproportionate influence. It has helped us bring us iPhones, electric cars, social media, and life-saving drugs. The system also has built-in incentives to sometimes not look too much for low-quality finances and ignore bad behavior.

During the Holmes trial, some finance professionals admitted to issuing checks to Theranos without seeing the financial statements or doing much to verify its technology and promises, despite their doubts about the company’s claims. Theranos raised nearly $ 1 billion from investors, and that evaporated when the company closed in 2018.

Theranos had a grand vision to make blood tests faster, cheaper and more accessible. But his machines to perform laboratory tests with a blood prick did not work as the company said. The question now is whether Holmes knew Theranos couldn’t keep the promises he made and lied about it. She pleaded not guilty and testified that she did not intend to defraud or deceive anyone.

As my colleague Erin Griffith has pointed out, Holmes’ attorneys said the firm’s investors should have known better and done their own due diligence. (Some did.) Prosecutors said they made their decisions based on false information.

Perhaps some of the investors who bet on Theranos were ignorant or negligent. But believing in promises that are too good to be true is not necessarily disqualifying from investing in a start-up. If the mission is to find a handful of diamonds in a sea of ​​garbage, it might not be worth spending the time and resources to eliminate potential failures or frauds.

Sometimes I wonder, half-jokingly, if the folks who travel the world looking for budding tech superstars and cheering them on for success, better throw money at everyone with an idea. business and leave them alone. This is not very far from the strategy of SoftBank, the Japanese conglomerate which is one of the largest start-up investors in the world.

It is not without consequences. Investors and boards often give start-up founders a lot of power and little control. Some start-up executives spend years building shaky businesses without their funders calling them for it. Others To pay oneself a bunch of money or run their businesses like a house of fraternity.

Part of me understands the cold rationality of being lax with young companies. Maybe Adam Neumann will be turn WeWork, the office rental company he helped start, into a trillion dollar business if investors let him do what he wants. If he does, riches are raining down on everyone. If he doesn’t – and he hasn’t – investors are on the next potential winning ticket. (Neumann was not charged with fraud, and WeWork continued without him.)

Holmes said during her trial that investors wanted her to get a big picture of the momentous change Theranos could trigger in the world. She said, in essence, that if Theranos had had more time, it could have turned out to be the life-changing business she envisioned.

Whether convicted or not, Holmes is right about the nature of investing in startups. This is on believe in a fantasy. Sometimes that wire becomes Tesla, and a lot of people get rich. And sometimes that fantasy evaporates. This is part of the package.


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