Venture capital, lies and theranos

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Last week, a jury declared Elizabeth Holmes, the entrepreneur behind biotech startup Theranos, guilty on four counts of fraudulent deception of investors.

What’s crazy is how sophisticated his defrauded investors were.

They included some of venture capital’s biggest heavyweights, like Larry Ellison, Tim Draper, and Don Lucas. There was even media mogul Rupert Murdoch and the wealthy heirs to the founders of Amway, Walmart and Cox Communication.

This is not the first time that such fraud has occurred. The Adam Neumann-centric WeWork story is another story of deception.

Both stories highlight one reality for investors looking to get into private equity: do your homework!

Today we bring you the latest issue of Venture capital collection from our private equity specialist, Cody Shirk. In it, Cody details the stories of Theranos and WeWork, emphasizing the critical importance of due diligence.

It’s fascinating read. I’ll let Cody take care of this.

Have a nice week end,

Jeff Remsbourg

What we can learn from the Theranos and WeWork stories

By Cody Shirk

They are outspoken, great thinkers, natural leaders and a bit unpredictable. They are extremely intelligent, a bit narcissistic and a force that keeps on advancing no matter the obstacle.

I’m talking about entrepreneurs who have the X factor. It’s almost impossible to pin down, but successful venture capitalists know how to spot this winning combination of outstanding traits.

It’s rare to find someone who has what it takes to build something from scratch. The requisite intelligence, creativity and enthusiasm are given, but it is the ability to overcome seemingly impossible challenges, while keeping a cool head and a big smile, that sets this rare breed apart.

While the methods for achieving this vary widely, in the end, successful entrepreneurs win by continuously executing their goal.

However, some entrepreneurs are better at selling a dream than achieving their goal… and it can be a disaster for investors.

Today I’m going to share the stories of two dream sellers who have raised billions of dollars in private funding from some of the biggest names in the business. But these dream sellers failed to achieve their ultimate goals and the investors ended up losing big.

I’ll share these caveats – and some tactics you can use to avoid making the same mistakes …

The dream seller who ran away

Measuring 6ft 5in, Adam Neumann was the man who sold the dream of “working together and belonging” to some of the best venture and private equity investors in the world.

Neumann was able to forge incredible financial ties by building We work (NYSE:WE). Softbank (OTCMKTS:SFTBY), Harvard Management Group, Reference capital and JPMorgan Chase (NYSE:JPM) were just a few of the institutional investors who believed in WeWork.

Jamie Dimon, CEO of JPMorgan, was even one of Neumann’s advisers. This relationship and others have enabled Neumann to raise more than $ 11 billion in just under a decade.

WeWork’s initial business model was to lease large office space cheaply through long-term leases, and then lease small plots of those properties to small businesses and individuals, especially startups. The goal was a collaborative environment where ideas could be shared and leveraged.

Founded in 2010, WeWork grew to 390 sites in 2019, the same year the company was scheduled to go public with a valuation of nearly $ 50 billion.

But just before the IPO, major questions started to arise …

WeWork’s main competitor, IWG (OTCMKTS:IWGFF) (which operates Regus), was already a public company and traded at a market cap of less than $ 5 billion. WeWork, which had far fewer locations and burned money, was 10 times more valued than Regus. Why?

From a 2019 Wall Street Journal article:

“The IWG comparison also raises questions about whether we[Work] worth what its funders say: IWG has been profitable for years and has a market cap of around a tenth of a Wee[Work]The private valuation of $ 47 billion, despite the announcement of big losses.

In the first half of 2019, IWG made approximately $ 60 million in profit, while WeWork lost $ 1.37 billion!

After WeWork filed to go public in 2019, potential public market investors had a field day with its financial documents. They discovered Neumann’s mismanagement and questionable personal activities.

For example:

  • JPMorgan has provided Neumann with a $ 40 million line of credit for his personal real estate purchases.
  • As CEO of WeWork, Neumann bought personal residences for $ 90 million, including a 60-acre farm estate in upstate New York, a 6,000-square-foot apartment in Manhattan, two houses in the Hamptons and a $ 21 million California mansion. A $ 40 million line of credit from JPMorgan covered part of that bill.
  • Neumann personally purchased commercial real estate which he then leased to WeWork, funded by investor money. This is an obvious conflict of interest: WeWork investors were literally paying off Neumann’s personal home loans. Legendary real estate investor Sam Zell said these transactions “would never have happened if WeWork was a public company and reviewed accordingly.”
  • Neumann personally deposited “Us” and sold it to the company for $ 5.9 million.

WeWork was not made public in 2019, and Neumann resigned as CEO in October of the same year. (However, he got a nice $ 1 billion severance package for leaving the company!)

WeWork finally went public in October 2021 through a Special Purpose Acquisition Company (SPAC) and is trading today for a market cap of around $ 6.5 billion. And even that “defies belief” assessment, based on a comparison with IWG.

Fast forward to today… and Neumann is once again making the headlines.

It is reported that he owns over 4,000 apartments valued at over $ 1 billion in total. According to a report by the WSJ, he plans to “build a business that would shake up the rental housing industry” and “create a widely recognizable apartment brand with amenities.”

Obviously, Neumann is a master at selling a dream, selling an idea. But he couldn’t make that dream come true… and investors lost a lot of money.

The dream salesman who got caught

Although you may not know the history of the private healthcare company Theranos, you’ve probably seen Elizabeth Holmes’s name in the headlines lately. California jurors have just convicted Holmes, the company’s founder and CEO, of wire fraud and conspiracy, and she could spend up to 20 years in prison.

Holmes was convicted of four counts relating to investor fraud and not guilty of all counts relating to patient fraud. The decision is remarkable – the court ruled in favor of investors who lost hundreds of millions of dollars backing the young blood testing company.

What separates Holmes and Theranos’ downfall from other dream sellers, such as Neumann, is that she outright lied and fabricated information to attract big investors.

Holmes has covered dozens of major media outlets. Inc. the magazine even called her “the next Steve Jobs”.

While it’s generally okay for entrepreneurs to pitch big ideas and sell dreams to investors, it’s unacceptable to falsify information – which Holmes has done … widely.

Theranos claimed to be able to perform over 200 tests from a single blood stick, all with a machine that could sit on a desk.

However, the company actually only performed a dozen tests, and those tests were performed with traditional industrial lab equipment at off-site sites. To make matters worse, many test results were inaccurate.

Despite all of this, Holmes was able to attract some serious muscle to the Theranos board, which added to the illusion of legitimacy.

The board members included:

  • Former Secretary of State Henry Kissinger
  • Former Secretary of Defense William Perry
  • Former US Senators Sam Nunn and William Frist
  • Richard Kovacevich, former CEO of Wells Fargo & Co. (NYSE:WFC)
  • William Foege, former director of the Centers for Disease Control and Prevention
  • Gary Roughead, former admiral of the US Navy
  • Riley P. Bechtel, Former Chairman of the Board of Directors of Bechtel Group Inc.
  • Jim Mattis, former General of the United States Marine Corps (and future Secretary of Defense)

It should be noted that none of these people will face charges or repercussions (except perhaps a slight damage to their reputation).

Ramesh “Sunny” Balwani, second in command of Theranos and Holmes’ boyfriend, is due in court in the coming months. Her case will likely be along the same lines as Holmes, given that he helped her and the company fake information to attract investors.

If you want to test your BS detector, you can listen to a 2013 recording from Holmes introducing Theranos to investors here. This specific call led an investor to increase his stake in the company by $ 5 million.

TO WATCH : In 2021, the film WeWork: Or the Making and Breaking of a $ 47 Billion Unicorn was released on Hulu. HBO broadcasts the documentary The inventor: in search of blood in Silicon Valley. They are worth the detour for any private investor.

What can we learn?

Do your due diligence!

Of course, that’s easier said than done. The two companies – WeWork and Theranos – have won over many legitimate investors. But as all private investors learn eventually, everything can and will go wrong in the startup world. It’s up to you to do your homework.

It’s easy to get carried away by the excitement of a new private opportunity. The fear of missing out (FOMO) surrounding hot new startups can cloud even the eyes of the most savvy investors.

I have said it before and I will say it again …

If a company makes implausible claims, demand proof. You can usually discover a lot more than you think.

Get your questions answered. Don’t be afraid to be “the person who asks uncomfortable questions”.

It’s your money. Don’t be afraid to dig deep and seek out the information you need to feel comfortable. You will end up saving yourself a lot of money in the long run.

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