From a valuation of $10B to 11 years in prison

The fucked up ethics of the startup world

Elizabeth Holmes founded Theranos as a 19-year-old college student.

Her goal was to "democratize healthcare". The fear of needles motivated her to look for a blood testing solution that requires a very small amount of blood, taken from the fingertips.

Professors and doctors she consulted with told her it was impossible, but Elizabeth knew she’d prove them wrong.

So far - the good old story of many successful startups. A talented and confident young kid, setting out to change the world (same as Google, Facebook, Microsoft, Apple).

And now the interesting part begins.

The article is based on the amazing book ‘Bad Blood - Secrets and Lies in a Silicon Valley Startup’ by John Carreyrou (4.4 on goodreads!)

So what happened in Theranos?

For the first 10(!) years, the company was in stealth mode, raising additional funds at an increasing valuation every couple of years.

They worked on a machine called ‘Edison’, which was supposed to run 240 tests on a drop of blood within minutes, and at a fraction of the cost of current technology.

Theranos launched the commercial product in 2013, signed a bunch of partnerships, and reached a peak valuation of $10 billion in 2015 (with Holmes owning 50% of the company!).

What went wrong?

Holmes really wanted to make her idea work. She hired real scientists, and they had some breakthroughs.

The problems started in 2009, when Holmes hired Ramesh "Sunny" Balwani as the COO. Sunny previously worked at Microsoft and Lotus, and then got lucky with a short stint in CommerceBid - a software company he joined in late 1999, which was sold 8 months later right at the pick of the dot com bubble, earning him $40M.

The problem? He was her boyfriend, whom she met in high school (when he was 37 and she 18).

The bigger problem? They didn’t tell anyone about the relationship. A lot of big lies start from a small deceit.

At first, it was just exaggerations - saying the product is better than it is, and they’ll deliver faster than they actually can.

4 years later, in 2013, they knew their product didn’t work as promised, but they decided to go on, and it transformed into pure lies.

At one stage, Theranos started to use blood testing equipment from other companies, saying the results came from their ‘Edison’ machine. As they used tiny amounts of blood, the results were inaccurate at best, making it criminal and dangerous for the patients.

Why did they do it?

Ambition and pressure.

Once they started with lies, there was no way out of it without giving up on the dream, and facing public shaming.

From the testimonials in the book, it seems like Holmes even convinced herself that it would all work out somehow.

People described here as trying to behave like Steve Jobs, aiming for the same 'reality distortion' field (Jobs was famous for continuously demanding the impossible from his subordinates, which made them achieve amazing results).

But in the end, she had only the charisma and the will, and almost no scientific knowledge (or good decisions) to back it up.

This is how she once tried to explain how their ‘invention’ works:

“A chemistry is performed so that a chemical reaction occurs and generates a signal from the chemical interaction with the sample, which is translated into a result, which is then reviewed by certified laboratory personnel."

And her COO/boyfriend was no better:

Balwani was known for using technical terms he seemingly did not understand to appear more knowledgeable. He once misheard "end effector" (the claw or other device at the end of an automated robot's arm) as "endofactor" (a nonsense word) and repeated the error throughout a meeting, furthermore not noticing when "Endofactor" was subsequently used as a prank in a PowerPoint presentation.

When people from inside the company tried to raise the red flag, they were ignored or dismissed.

By 2015, people started to get suspicious, and investigative reports followed. John Carreyrou, then an investigative reporter for The Wall Street Journal, exposed the company's false claims in a series of articles.

In the end, both Holmes and Balwani were found guilty, and sentenced for 11 and 12 years respectively.

Elizabeth Holmes is in good company

Huge frauds seem to be everywhere around us.

Sam Bankman-Fried, the genius geek, was found guilty on multiple charges, in a case that’s called one of the biggest financial frauds in American history. He is facing a few decades in prison, the final ruling will be in March 2024.

Charlie Javice will also go to trial in 2024, over lying to JPMorgan about the actual data her startup has. Her’s is an advanced type of fraud, using a data scientist to generate fake data about 3M customers!

This trifecta is a recipe for disaster:

1. A charismatic leader

2. Tons of VC money

3. Social attention and high-status

I recently read this great article in

Data-driven VC

by

Andre Retterath

, on transparency in the VC world. He mainly talks about it in the scope of VC performance, but my mind kept circling back to Theranos.

When you are a young entrepreneur, all that money and success can easily get into your head. Shouldn’t the VCs act as responsible adults here? How come none of the board members knew what happened, or stopped it? (In all 3 cases - FTX, Theranos and Frank). A similar story happened with Adam Neumann, WeWork, and Softbank - not a criminal fraud, but a spectacular over-abuse of power and collapse.

Ethics in the startup world - judging only the losers

Let’s assume Theranos’s idea would have worked. Somehow by the end of 2015, they would have finally reached that breakthrough, transforming the medical world.

Do you have any doubt she would have evaded any charges? And that the VCs and media would have forgiven the lies?

Holmes would have been depicted as the ‘daring entrepreneur’, defying all odds and pushing her company to success. As long as someone makes money, ethics don’t apply to them.

Let’s take Musk as an example. He once ignored FAA instructions and launched a rocket in bad weather. Imagine what would happen, if a rocket with astronauts had exploded in that flight. I’m sure that suddenly tons of critics will pop up, saying how he ignored all safety regulations for years.

It all starts with small exaggerations and unreasonable goals. Imagine you start a startup, and decide to raise VC money. You know you won’t reach $10M in revenue in 3 years, but you also know that this is what you need to say. So you set an unreasonable goal.

2 years later, you are barely at $1M, and you are out of money, looking for the next round of funding. You now need to aim much higher - you finally found the product-market fit, and you predict to be in $50M in 4 years! 400% increase each year!

And the snowball begins. The VCs need crazy growth to get to an exit/IPO (and generate great returns for the LPs), so they keep pushing you to perform harder.

As long as in the end, you generate money for the VCs - you’ll get your Forbes 30 under 30. But if you are caught… Good luck.

Final Words

I think it is a must-read for every entrepreneur. When your company’s future is on the line, and you know that if you tell the truth, you won’t get investments and it’ll all collapse, how would you react? I’m not surprised people can’t resist. It’s too easy to fall into the ‘it’s just small a lie, I’m changing the world here, who cares!’ trap.

How can we change that norm?