Elizabeth Holmes is guilty of fraud. That refreshingly simple fact wraps up years of misrepresentations and lies that caused a $9 billion valuation and around $1 billion of invested capital to vanish.
On charges of deceiving investors, Holmes was convicted on four counts, and jurors were deadlocked on another three. She was acquitted on all four counts of defrauding patients.
The moral of the story is less clear. Tech’s critics see the trial as a reproach of the “fake it ’til you make it” startup culture. Meanwhile, Silicon Valley’s defenders argue Theranos was never part of its club. Likewise, the saga was both a condemnation and vindication of the tech media, which first inflated Theranos’ hype before dismantling it through investigative journalism.
The jury’s decision comes during heady times for venture capital, which is an open invitation for the Holmeses of the world. This week, the tech world reflected on another record-shattering year—$329.8 billion in US venture capital investment was raised in 2021, nearly double the previous year. There’s arguably never been a better time to be a huckster in VC.
The remarkable thing about Holmes, a Stanford dropout who dressed like Steve Jobs, was how widely her deceptions were accepted.
The company’s cap table included powerful political figures like Henry Kissinger, media titan Rupert Murdoch, and Walgreens. Tenured Bay Area tech investor Tim Draper was an early investor. As vice president, Joe Biden hailed Theranos as “the laboratory of the future.” Forbes put a 30-year-old Holmes on its cover.
“Everyone gets it wrong, sometimes,” Arlan Hamilton, founder and managing partner of Backstage Capital, tweeted this week. In 2015, Hamilton praised Holmes and even booked an appointment (later canceled), to have her own blood tested by Theranos.
The odds of getting it wrong have increased lately as investors lose bargaining power. This shift is even quantifiable: The PitchBook VC Dealmaking Indicator has shown a marked trend toward founder-friendly dynamics since mid-2020. Deals are getting bigger and moving faster as heightened competition winnows away time for due diligence.
It all adds up to ripe conditions for exploitation. But in an up-and-to-the-right market, everyone seems brilliant until they’re proven foolish.
Theranos underscores a nuance of the VC world: You can paint an unrealistic picture of the future all you want, but you can’t lie about the past or present.
“There’s an element that all startups have—they’re selling a proposition beyond reality,” said Chris Sugden, managing partner at Edison Partners.
In 2014, during a boom time for VC, Theranos raised $633 million, according to a PitchBook estimate, at a $9 billion-plus valuation. A far greater expansion of overall US VC investment has followed in recent years, upping the stakes in an already risky business.
Over the years, deal dynamics have tilted in favor of founders, a change that can be gauged by the supply and demand of capital as well as the use of deal terms that illustrate the investor-founder relationship.
Factors driving the founder-friendly shift include a sharp increase in valuation step-ups across stages, as well as long-term declines in investor-friendly terms like cumulative dividends, which accrue over the life of an investment and are paid out to investors in an exit.
These days, founders have more investment options than ever and are no longer limited to the traditional VC set. PitchBook data shows that about 77% of US VC deals by market value in 2020 included participation from a nontraditional investor, a wide-ranging category that includes private equity backers, sovereign wealth funds and family offices.
There’s also a movement to open startup investing to an even larger category of investors, both accredited and not, fueling a debate over how to widen access while protecting investors.
As founders gain more power, investors may feel pressure to skimp on due diligence or general supervision of portfolio companies. Sugden said that founders have increasingly pushed for ever-shorter deal timelines and want to cut back on so-called representations and warranties, a series of founder disclosures that give investors a clearer picture of what they’re betting on.
Founders who cross that line between hype and lie may get away with it. Investors accept the risk that most of their bets will fail, and rarely take founders to court, in part to protect their own reputation.
Add to that the fact that prosecution of white-collar crime has fallen by 54% since 2011, according to TRAC Reports, a data and research group at Syracuse University. Moreover, although Holmes faces up to 20 years for each count of fraud, perpetrators of financial crimes frequently receive lenient sentences.
Even disgraced founders have a way of bouncing back: WeWork founder Adam Neumann is getting back into the real estate game a little more than two years after ceding control of the company. Neumann has been busy purchasing majority stakes in thousands of billion-dollar apartments, The Wall Street Journal reported this week. The venture is said to be self-funded.
All investors can do is stick to their principles, even when doing so may result in missing out on some deals.
“Don’t allow the hype of the market to not let you read what the diligence is telling you,” Sugden said. “When we look back at deals that didn’t work out, it’s always much more obvious in hindsight. Let’s not kid ourselves.”
Correction, Jan. 11: An earlier version of this article stated that DFJ was a repeat investor in Theranos. DFJ made an early investment in Theranos but did not reinvest.
Featured image by David Odisho/Getty Images
This article originally appeared on PitchBook News
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