A Great Idea Does Not a Business Make

Bad Blood by Carreyrou is an exemplary tale of a business going bad. It is in line with two other classics, The Deal of the Century by Coll and Barbarians at the Gate by Burrough and Helyar. The former depicts the beginnings of the collapse of AT&T and the second the complex takeover of Nabisco. Both of these tales result in a restructuring of businesses for better or worse. In this case it describes probably the worst behavior seen in a startup and the destruction of whatever business was conceived.

This is a tale of people who seem to have been brought into a techno-cult, many smart young people who got proselytized by an even younger individual who managed to present herself as super competent but who fundamentally was both intellectually and morally flawed. This book does not depict a tragedy, except perhaps for the young employees who wasted years of their lives and frankly may be forever scarred, but it is a book about the ability for a perverse individual and co-conspirator to convince a significant number of allegedly competent people to dismiss their fundamental judgments regarding any other comparable effort. There was a suspension of belief on the part of many otherwise shred people and the acceptance of this almost cult like persona.

I approached this book having done about 35 start-up and turn-arounds, as the principal or investor. Many did well, many were stalled mid-stream, and none went bankrupt. In the process I often saw that my initial premise was altered and thus the business model changed. However in almost all there was a need for a plan and a reporting on the plan to a Board who had a modicum of confidence. In some cases I had Directors call first thing Monday to see what the cash flow of the prior week was and compare it to plan. Reality was always at the fore. Plan and actuals, and interaction with hands on boards.

I have seen deals where one had to pull the plug when reality and expectations were dissonant. In one case an entrepreneur in an investment could not reproduce the core result and worse yet even if they could they had no way to manufacture it. That is not a way to run a business.

Now fundamentally any investor, and especially a Director, must have an understanding of their Fiduciary Duty to the other shareholders. That means effecting a process of effective due diligence. Due diligence is demanded in any investment and it fundamentally entails: (i) that the product or service can be accomplished, (ii) that management has the competence to do so, (iii) that the price point is highly competitive and the margins are appropriate, and finally )v) that the people one is dealing with are honest and competent. It appears that in the case of Theranos that many never did their Due Diligence. What is amazing is that the venture investors would never allow themselves to invest in any deal without do it and also the “big name” Directors most likely had no idea what that entails. In my experience of the 100 companies I would look at, 2-3 would ultimately pass the test, 80-90 would be dismissed out of hand and the remaining would never pass Due Diligence. It appears that if one accepts the author’s tale, and why not, then there never was any due diligence. “Trust me” is not the basis for major investments, by investors, Directors or joint venture partners.

The author describes in full detail the creation and buildup of the company and how it managed to go through hundreds of millions of dollars and at the same time achieve nothing. The battles between the top managers and the staff, the high rates of turnover and the outright prevarication of the principals. What is most astonishing and the again all too often the case is the tale of how the principals dealt with a sale to the DoD and that one officer managed to ask a question and the principal manages to go to a four star general, now a prominent person in Washington, who then believing this principals calls out his own person. Marines should not, must not, do that; it demonstrates in my opinion lack of judgement, and lays the ground for questioning any subsequent judgements. But the author shows that this example was not in any way unique, if anything it was a pervasive behavior on the principal’s part.

Overall this book is a tale of one individual after another interacting with the principals and how they were manipulated and then thrown aside.

What this book does not do is more important. This is not a criticism since answering these issues may fall into the criminal and civil litigation forthcoming. But specifically:

1. Why did none of the accredited investors perform due diligence? Or were there some who tried and then walked away? The book alludes to many of the investors but they seemed to like sheep, just following the herd. This were all competent people. It would be important to understand why they did investments, often of significant amounts, and not due the due diligence and furthermore not demand Board rights.

2. Why did the Directors allow themselves to sit by and have management do what they did? Directors have a fiduciary duty and it appears that none of them were either aware of what their duty was and/or did they have the competence to even ask the questions. The Directors were all prominent people in the fields, but unfortunately none appeared to be experienced in this area. The book does not in any way address the Directors in detail. That would be an important analysis.

3. One of the most significant “red flags” in any business is the loss of a CFO. When the first CFO left, the Board should have individually meet and questioned him as to why he left. One can understand that the CFO was bound not to speak to others but he can and must speak to the Board. The question is; why not?

4. The fact the young principal owned a tremendous controlling interest and as such could block anything she desired from happening should have raised red flags as well. One must ask; why not?

5. The biggest unanswered question seems to be; where did all the money go? They seemed to have Safeway and Walgreens pay their own way, the attorneys clearly costs a small fortune, but if the company had a running number of employees of say 100, and the fully loaded costs per employee were say $200,000, then the annual burn rate for the company less CAPEX was $20 million, Even at large CAPEX and attorney fees, one must ask where the money went?

The author tells the tale via the many employees and their interactions with the two principals. But the other dimensions, namely the investors, Directors, business partners, must be folded into the mix. Again it is perhaps too early to get this tale told properly, but if one is to gain anything from this fiasco then one must understand those dimensions as well. If only someone had been able to do due diligence. Its lack was the classic red flag!