If you have been following the trial of former Theranos CEO Elizabeth Holmes, you may be wondering how so many wealthy, well-informed and sophisticated people were duped into investing hundreds of millions in a sham company. Unfortunately, their financial blind spots are all too human. We can try to avoid making similar financial mistakes – albeit on a much smaller scale – by taking a look at what appears to have been their collective frame of mind.
For those unfamiliar with Theranos, the company was a Silicon Valley start-up that claimed it could run complete blood tests with just a prick of a finger. But investigative reports by John Carreyrou of the Wall Street Journal in 2015 questioned the legitimacy of Theranos’s technology. (I highly recommend reading Carreyrou’s book, “Bad Blood: Secrets and Lies in a Silicon Valley Startup” as well as his current podcast on the matter, “Bad Blood: The Final Chapter.”) Subsequent examinations showed that Theranos relied on traditional blood machines for the majority of its tests; its own machines were essentially worthless. Holmes, who fashioned herself in the image of Steve Jobs, was charged with defrauding investors and patients.
Buying Into The Theranos Story
Theranos received substantial support from a high-profile group of investors. The names and the amounts they invested include Rupert Murdoch ($125 million), Walmart founders the Walton family ($150 million) and Betsy DeVos and her family ($100 million). Even former U.S. Secretary of Defense, Retired Gen. James Mattis, put in $85,000 – an amount he says was significant for someone whose career was spent in government service. How were they tricked?
It comes down to a persuasive story told by a compelling storyteller who, the prosecution asserts, lied to them repeatedly and hid the reality of the company’s operations and results. Eventually, the federal government saw through the company’s smokescreen and shut it down to prevent public harm.
Holmes was a masterful media manipulator who received extensive TV and print coverage. But as some of those outlets later admitted, they took her word for the company’s performance, never looking behind the curtain. Essentially, they bought the image of Theranos because the idea of quick testing with just a fingerprint could revolutionize some aspects of healthcare. Gen. Mattis, for example, thought the tests would be invaluable for military forces in the field where standard labs were hundreds or thousands of miles away.
Some Potential Investors Did Their Due Diligence
Not everyone that Theranos solicited went along with the story. The investment division of Google – Google Ventures – didn’t get the answers it wanted from the company. So they sent one of their life-sciences experts to investigate and learned that the finger-prick testing wasn’t happening, but rather standard blood-drawing techniques were being used. They decided to pass, as did a number of others.
While Silicon Valley investors don’t always insist on seeing hard financial evidence of a start-up’s viability, there’s allegedly a greater emphasis on transparency and data now in the wake of Theranos.
Implications For The Rest Of Us
It’s easy to get swept up in the enthusiasm of the crowd. People we know and admire can be all the evidence we need to make financial decisions that aren’t necessarily right for us. A couple of examples:
- Your buddy has told you how well he’s doing renting out a small property as an AirBnB. While on vacation in your favorite resort area, you see a house for sale and think of converting it to an AirBnB destination yourself. But you know nothing about it, what it takes to operate such a property, and what the market rate is for AirBnB’s in the area. Taking out a mortgage on the house in this situation is at best a shot in the dark.
- The classic example of bad peer influence is the “hot stock tip” passed along at a cocktail party. In this case, most of the financial advantages of the tip may have disappeared before you got the tip. The tip can go the other way as well – advice to dump a stock before it drops precipitously, only to see it continue to rise and stay high for years to come. (I explained why I don’t chase individual stocks for similar reasons in a previous blog.)
Murdoch, Kissinger and Mattis made the mistake of jumping in without looking carefully and objectively at what they were buying. Given their lack of expertise in healthcare technology and the science supporting it, they probably should have been far more cautious.
The takeaway is something that perhaps the most famous investor of our time, Warren Buffett, uses as his watchword: “Never invest in something you don’t understand.” Put another way, if your friends advocate a financial decision, don’t go along unless you have clear, objective evidence supporting it, and especially that it aligns with your personal financial goals.
Have a financial opportunity you’re uncertain of? Contact us and we can help you figure out what you need to know before you move forward.
