There are few examples of corporate fraud that have crashed and burned in the public eye quite like Theranos. Theranos, a Palo-Alto based healthcare start-up attracted hundreds of millions of dollars over the span of its life. At one time, the firm reached a valuation of 9 billion dollars. The company, led by Elizabeth Holmes, claimed that its device could conduct various kinds of tests based only on a few drops of blood. In 2015, however, the company started to collapse after a Wall Street Journal reporter, John Carreyrou, exposed the questionable efficacy of Theranos’ technology.
According to the Securities and Exchange Commission, the company both exaggerated and falsified claims regarding its technology and business performance. The distance of Theranos’ reality from the vision it conveyed begs the question: how did Theranos manage to attract so many investors?
The respective cultures of the Venture Capital industry and Silicon Valley both contributed to Theranos’ successful deception of investors. Both industries’ cultures foster an environment that encourages companies to innovate as fast as possible. Because most start-ups are private companies, they have very few transparency requirements, and hold no legal responsibility to publish earnings and annual reports.
Theranos thus managed to raise millions of dollars with no burden of proof regarding the efficacy of their technology. This issue was further exacerbated by a legal loophole which allowed lab-developed tests in a single laboratory to sidestep safety trials issued by the Food and Drug Administration (FDA). Such a lack of transparency allowed Theranos to make unattainable promises in the short-term to gain funding, thereby contributing to a gap between the actual technology and the company’s vision.
The complexity of the healthcare industry renders it particularly difficult for investors to assess the effectiveness of technologies, making narratives extremely important for early-stage funding cycles. Holmes sold a vision which had a strong emotional appeal to many people. She often spoke about her uncle, who had skin cancer and passed away. She then referred to how the blood testing technology would be able to save lives so that “less people [will] have to say goodbye too soon”. Holmes combined a vision of a world made better through technology with a personal anecdote, through which she courted greater trust in Theranos’ vision.
Many high-profile investors, such as Rupert Murdoch and the Walton family of Walmart, invested early in Theranos’ early stages. The company also had the support of David Boies, a famous lawyer, who sat at every board meeting. Moreover, Holmes cultivated bonds with the White House and the Clintons. These relationships helped confirm the validity of Theranos, creating a bandwagon effect for investors and funds. The net result was a web of influential backers and a business built on smoke and mirrors.
Overall, the culture of Silicon Valley, the unpredictableness of the healthcare industry, and the emotional appeal of the vision explain how Theranos was able to draw in many supporters. What stands out is a key issue in space. The gap between a start-up’s vision versus the actual realities of tier operations (especially in the healthcare industry) needs to be examined more closely going forward. With the rise of growing regulatory pressure in the tech industry, perhaps regulations around funding for biotech start-ups might be around the corner as well.