The Lessons of Theranos

Watched the HBO documentary on Theranos. I put the trailer above so you can get the gist of what it is about. If you don’t know about Theranos, it’s seen as a totally failed experiment or a fraud depending on your perspective.

The first lesson of Theranos is that the venture business is a tough business. There is failure. Sometimes after investing and spending a lot of money there is failure. The other day an Alzheimer’s drug failed in FDA testing after millions were invested and spent. Theranos spent $900MM; $300MM on legal fees. Fully one third of invested capital went to lawyers.

Some of that money was spent in defense but initially a lot of it was spent because they had to run down the labyrinth of government regulation. Our government over regulates businesses. The government also makes a lot of mistakes. People get hurt. A friend lost a son to stomach cancer this past week and it’s likely it was caused by a Sterigenics plant emissions in Willowbrook, IL.

When it comes to ventures in the medical industry, they can be very expensive.  Labor, labs, testing, lawyers, and the time to market are very high which drives up the cost to get something done.

What was interesting to me is the people that Holmes was able to get around her. Henry Kissinger and George Schultz on a seed stage startup board? Friend of Obama and Clinton? This could be taken as a sign that crony capitalism was a path she deliberately was going to walk down given the wall of regulation she was going to have to traverse.

The second lesson is that investors need to do complete diligence. Walgreen’s didn’t. No investor did. I don’t blame the seed investors. They invested pre-product in an idea. They put their faith in Holmes that she could execute. This happens a lot in the Valley and most of the time it doesn’t work out but when it does it’s a moon shot. You get a sense of that from Tim Draper who invested in Tesla, Baidu, and plenty of other companies that went from idea to the pay window for him.

When I invested in UICO, it was not close to a working product.  It was a rudimentary tablet looking thing.  I bet on the idea, and the people behind it.  When I invested in NuCurrent, they had somewhat of a product.  It worked in a lab.  There was a competitor named UBeam who’s tech wasn’t the same and ultimately failed in its initial iteration.  We had long discussions during diligence about the viability of the NuCurrent tech, the competitive landscape, and the path they would run down.  We consulted with scientists that had nothing to do with the company.  Like Theranos, one scientist who was very well respected in the field left the lab to join NuCurrent.  When that happens, it lends total credibility to the company.  You need to find out what the motivations of the scientist are in order to ascertain what is going on.

Theranos never really had professional institutional investors in later rounds.  It was all family office type money or wealthy individuals.  They used piggyback diligence to rationalize investment.  Doing diligence can be painstaking and time consuming work.  It’s never fun.  People often will rely on others if they can.  The earlier a company is in its cycle, the less diligence that needs to be done.  That’s why you will hear stories of seed checks being cut after one meeting.

Theranos used attorneys to threaten and frighten employees.  I wonder how often this goes on in other companies both startup and public?  Creating a culture of fear among employees never works.  I go back to the Schofield Address to the Class of West Point in 1879 and it rings true today.  Dissent has to be allowed and needs a certified process and channel to move through.  This is especially true in scientific projects where you are doing a lot of hypothesis testing.  One of the red flags for me in the whole global warming issue is the way dissenting scientists were treated by peers.  The power brokers tried to destroy their reputations and careers.

Theranos wasn’t transparent at all. They relied on the “trade secret” line.  It’s certainly acceptable when talking to the press.  It’s not when talking to investors.  There was deliberate deception on the part of Theranos.  When caught, they lied. They not only lied to employees but the outside world.  They saw it as a marketing problem rather than an internal one and a cultural one.  The responsibility for that falls on the C Suite.

As an investor, there is a level of trust that has to be present.  When an entrepreneur gives you numbers you can verify them, but if you are doing diligence there has to be a mutual trust between the entrepreneur and investor.  I have been given fake numbers and it’s never pretty when the comeuppance happens.

Another lesson from Theranos goes back to Thomas Edison.  On the invention of the lightbulb, he wasn’t totally transparent.  But, it wasn’t because he had several things that weren’t working.  He had one thing that wasn’t working and he needed to figure it out.  Theranos didn’t have just one thing not working.  Each thing that wasn’t working was causing a bullwhip effect and that created a situation where instead of one week to fix something it might be six months.  Or longer.  Or never.  Theranos was never honest with investors, customers, or the public.

The truth is, sometimes the technology isn’t advanced enough to execute on the idea.  That’s why we have science fiction.

Another point I want to bring up that applies to Theranos and the trend of companies staying private longer is that public markets would have sniffed out the fraud a lot sooner.  There were several macrotrends that impacted Theranos the same way they impacted companies like AirBnb, Uber, and Lyft.  The cost of private capital was cheap for virtually the entire life cycle of Theranos.  0% interest rates and risk preferences changed.  Cheap money causes investors to take more risk.  Government regulation also makes it expensive to go public.

We focus a lot on wealth disparity in our public dialogue today.  Back when I was in my 20’s, I could have invested in Microsoft, Dell, Apple and other tech high flyers at company valuations of far less than $1B.  Today because of regulation, that window is only open to the 1%.  This makes it harder for people to build wealth.  As of November 2018 if I put $1,000 into Microsoft IPO (1986) it would be worth $1.6MM today.  If you put $1000 into the Lyft IPO, do you think you will get the same return?

There are many lessons to be learned from Theranos.  Some of them are ethical and personal.  Some are public policy issues that we ought to really take a hard look at.  Some of them are in process inside a company and when you make an investment.

They are hard lessons to learn.