Random Thoughts – Randocity!

On the heels of Elizabeth Holmes’s conviction for four counts of fraud, the question begs… Why aren’t more startup CEOs in prison for fraud? Before we get into the answer, let’s explore a little about Elizabeth Holmes.

Theranos

Theranos was a technological biomedical startup, not unlike so many tech startup companies before it. Like many startups, Theranos began based out of Palo Alto, California… what some might consider the heart of Silicon Valley. Most startups that begin their life in or around Palo Alto seem able to rope in a lot of tech investors and tech money. Theranos was no different.

Let’s step back to understand who was at the helm of Theranos before we get into what technology this startup purported to offer the world. Theranos was helmed by none other than Elizabeth Holmes. Holmes founded Theranos in 2003 at the age of 19, after she had dropped out of Stanford University. In 2002 prior to founding Theranos, Elizabeth Holmes was an engineering student studying chemical engineering. No, she was not a medical student nor did she have any medical training.

Clearly, by 2003, she had envisioned grandiose ideas about how to make her way in the world… and it didn’t seem to involve actually completing her degree at Stanford. Thus, Theranos was born after having she had gotten her dean, but not medical experts at the school, to sign off on her blood testing idea.

Medical Technology

What was her medical idea? Holmes’s idea involved gathering vast amounts of data from a few drops of blood. Unfortunately, not everyone agreed that her idea had merit, particularly medical professors at Stanford. However, she was able to get some people to buy into her idea and, thus, Theranos was born.

From the drawing board to creating a device that actually does what Holmes claimed would pose the ultimate challenge, one that would see her convicted of fraud.

Software Technology

Most startup products in Silicon Valley involve software innovation with that occasional product which also requires a specialty hardware device to support the software. Such hardware and software examples include the Apple iPhone, the Fitbit and even the now defunct Pebble.

Software only solutions include such notables as Adobe Photoshop, Microsoft Office and even operating systems like Microsoft Windows. Even video games fall under such possible startups, like Pokémon Go. Yes, these standalone softwares do require separate hardware, but using already existing products that consumers either own or can easily purchase. These software startups don’t need to build any specialty hardware.

Software solutions can solve problems for many differing industries including the financial industry, the medical industry, the fast food industry and the law enforcement industry and even solve problems for home consumers.

There are so many differing ideas that can make life much simpler, some ideas are well worth exploring. However, like Theranos, some aren’t.

Theranos vs Silicon Valley

Elizabeth Holmes’s idea that a few drops of blood could reveal a lot of information was a radical idea that didn’t, at her young age of 19, have a solution. This is what Elizabeth Holmes sought to create with Theranos.

Many Silicon Valley startups must craft a way to solve the problem they envision. Whether that be accessing data faster or more reliably to creating a queuing system for restaurants using an iPhone app.

It’s not so much the idea, but the execution of it. That’s where the CEO comes into play. The CEO must assemble a team capable of realizing and executing the idea they have in their head. For example, is it possible to create a device to extract mountains of data from a few drops of blood? That’s what Elizabeth Holmes was hoping she could create. It was the entire basis for the creation of Theranos.

Investors

To create that software and device, it takes money and time. Time to develop and money to design and build necessary devices using R&D. A startup must also hire experts in various fields who can step into the role and determine what is and isn’t possible.

In other words, a CEO’s plan is “fake it until you make it”. That saying goes for every single startup CEO who’s ever attempted to build a company. Investors see to it that there’s sufficient capital to make sure a company can succeed, or at least give it a very good shot. Early investors include seed and angel investors, where the money may have few if any strings and later stage investors such as Venture Capitalists, where there are heavy strings tied to the money in the form of exchanging company ownership in exchange for money.

Later stage investors are usually much more hands-on than many angel or seed investors. In fact, sometimes late stage investors can be so hands-on as to cause the company to pivot a company in unwanted directions and away from the original vision. This article isn’t intended to become a lesson for how VC’s work, but suffice it to say that they can become quite important in directing a company’s vision.

In Theranos case, however, Elizabeth Holmes locked out investors by creating a …

Black Box

One thing that Silicon Valley investors don’t like are black boxes. What is a black box? It’s a metaphor for a wall that’s erected between a company’s product and any investors involved. A black box company is one that refuses to share how a startup company’s technology actually works. Many investors won’t invest in such “black box” companies. Investors want to know how their money is being spent and how a company’s technology is progressing. Black boxes don’t allow for that information flow.

Theranos employed such a black box approach to its blood analyzer device. It’s actually a wonder Theranos got as much investor support as it did, particularly for a CEO that young and, obviously, inexperienced when insisting on a black box approach. That situation is ripe for abuse. At 19, how effective could Elizabeth Holmes be as a CEO? How trustworthy and responsible could a 19 year old be with millions of dollars of funding? How many 19 year olds would you entrust with millions of dollars, after they had dropped out of college? For investors, this should have been a huge red flag.

There’s something to be said for the possibility of a wunderkind in Elizabeth Holmes, except she hadn’t proven herself to be a prodigy while attending Stanford. Even the medical experts she had consulted about her idea clearly didn’t think she had the necessary skills to make her far-fetched idea a reality. A chemical engineering student hopping into the biotech field with the creation of small, almost portable blood analysis machine at a time when commercial blood analysis machines where orders of magnitudes bigger and required much more blood volume? Holmes’s idea was fantastical, yet clearly unrealistic.

However, Theranos’s black box, dubbed the Edison or miniLab, was a small piece of equipment about half the size of a standard tower computer case and included a touch screen display and blood insertion port.

Unfortunately, this black box was truly a black box in all senses of the word, including its actual case coloring. Not only was the Edison’s innards kept a strict company secret, its testing methodologies were also kept secret, even from employees. In other words, no one knew exactly how the Edison truly worked. No, not even the engineers that Theranos hired to try to actually make Holmes’s vision a reality.

Theranos and Walgreens

By 2016, Theranos had secured a contract with Walgreens for Walgreens to use Theranos’s Edison machine to test blood samples by medical patients. Unfortunately, what came to pass from those tests was less than stellar. It’s also what led to the downfall of Theranos and ultimately Elizabeth Holmes and her business partner, Sunny Balwani.

The engineers that Theranos hired knew that the Edison didn’t work, even though they hadn’t been privy to all of its inner workings. Instead, what they saw was those tiny vials of blood trying to run samples on larger blood testing machines like the Siemens Advia 1800.

When the engineers, Erika Cheung and Tyler Shultz, confronted Holmes and Balwani about the Edison machine’s lack of functionality and about being asked to falsify test results, they were given the cold shoulder. Both Cheung and Tyler decided to blow the whistle on Theranos’s fraud. Cheung and Schultz both left Theranos after whistleblowing to start their own companies.

Ultimately, Theranos had been using alternative medical diagnostic technology in lieu of its own Edison machine, which the Edison clearly didn’t function properly and neither did the third party systems with the amount of blood that Holmes stated that it required.

This left patients at Walgreens with false test results, requiring many patients to retest with another lab to confirm the validity of Theranos’s results.

Elizabeth Holmes Fate?

In January of 2022, Elizabeth Holmes was found guilty of 4 counts of fraud. However, the jury acquitted her of all counts involving patient fraud… the patients were, in fact, hurt the most by Theranos’s fraud. The jury awarded monetary rewards to the investors, not to the patients who may have been irreparably harmed by her machine’s failure to function.

Why aren’t more CEOs in prison for fraud?

While the Theranos and Elizabeth Holmes case is somewhat unique among Silicon Valley startups, it is not completely unique. Defrauding investors is a slippery slope for Silicon Valley. Once one company is found perpetrating fraud on investors, it actually opens the door up to many more such cases.

Taking money from investors to attempt to bring a dream to life is exactly what CEOs do. However, Theranos (and Elizabeth Holmes) between 2003 and 2016 couldn’t produce a functional machine.

Most CEOs, given enough time and, of course money, can likely produce a functional product in some form. Whether that product resembles the original idea that founded the company remains to be seen. Some CEOs pivot a year or two in and change directions. They either realize their initial idea wasn’t unique enough or that there would be significant problems bringing it to market. They then change direction and come up with a new idea that may be more easily marketable.

Startups that Bankrupt

In the case of Theranos, other startups that go bankrupt could signal the possibility that CEOs may now be held accountable to fraud charges, just like Ms. Holmes. The Elizabeth Holmes case has now set that precedent. Taking investor money may no longer be without legal peril directly to company executives. If you agree to bring a product to market and are given investor capital to do it… and then you fail and the company folds, you may find yourself in court up on fraud charges.

Silicon Valley investors do understand that the odds of a successful startup is relatively low… which is why they typically invest in many at once. The one that succeeds typically more than makes up for the others that fail. If more than one succeeds, even better. It’s called, “playing the odds”. The more you bet, the better chances you have of winning. However, playing the odds won’t stop investors from wanting to recoup losses for money given to failed startups.

The Elizabeth Holmes case may very well be chilling for startups. It’s ultimately chilling to would-be CEOs who see dollar signs in their eyes, but then months later that startup is out of cash and closing down in failure.

CEOs and Prison Time

Elizabeth Holmes should be considered a cautionary tale for all would-be CEOs looking for some quick cash to get their idea off the ground. If you do manage to secure funding, you should be cautious with how you use that cash. Also always and I mean ALWAYS make sure the progress in building your idea is shown to your investors regularly. Let them know how their investor money is being used. When software is available for demonstrations, show it off. Don’t hide it inside of a black box.

Black boxes have no place in startup investing. As with Elizabeth Holmes, she’s facing up to 20 years in prison. However, her sentence has yet to be handed down, but is expected to be no less than 20 years. Though, it’s possible she may be given the possibility of parole and the possibility of a reduced sentence for good behavior… all of which is up to the sentencing judge.

Elizabeth Holmes opened this door for startup CEOs. It’s only a matter of time before investors begin using this precedent to hold CEO founders to account should an investment in a startup fail.

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