US fake health technology scam a cautionary tale for executives

Disgraced Theranos chief executive Elizabeth Holmes in California. PHOTO | GLENN CHAPMAN | AFP

What you need to know:

  • unicorns don’t exist, especially when it comes to imaginary products.
  • At its peak Theranos was worth $9 billion, according to an internal valuation in 2014.

The story of the meteoric rise and spectacular fall from grace of Theranos, a US-based start-up, provides important lessons.

The company’s chief executive Elizabeth Holmes and its former President Ramesh “Sunny” Balwani were recently charged with fraud for soliciting more than $700 million of investors’ money behind a supposedly cheaper, more efficient and painless blood-testing technology.

It turned out these were bogus, non-existent inventions.

So how did all these seasoned venture capital-types get duped by a Stanford University dropout from when she was just 19?

DOTCOMS

We love fairytales. In the apt nomenclature, the Silicon Valley term for the rare astronomical success story is a “unicorn”.

There was always the chance that this revolutionary blood testing technology would join the FAANG club — the acronym for the biggest Silicon Valley shooting stars; Facebook, Apple, Amazon, Netflix and the parent company of Google.

The only difference was these large dotcoms had a real product or service that spoke to an unmet consumer need.

Whether it was being part of the Apple “tribe” that unifies large swathes of humanity in uber coolness (and signals progressiveness) or if you are on Facebook to connect with family and friends.

IMAGINARY

So lesson number one is unicorns don’t exist, especially when it comes to imaginary products.

One reason for the shareholders perceived rashness was the herd mentality.

In July 2011, Holmes recruited George Shultz, a former US Secretary of State, to be on the Theranos board.

It was no accident that in a couple of years the Theranos board comprised two former Secretaries of State (the other being Henry Kissinger), a former Secretary of Defence, two former senators, two retired generals, an admiral among others.

VARYING RESULTS

The glow of this star-studded board blinded both themselves and Theranos financiers.

And yet Theranos’ product was fundamentally flawed.

As Tyler Shultz, an ex-employee and whistleblower, stated: “Theranos propriety Edison machines frequently failed quality control checks and produced widely varying results.”

In fact, the Edison machine upon which all of Theranos prioprietary biotech expertise was based, was so unreliable that Theranos used conventional testing equipment from suppliers such as Siemens to conduct its own blood tests.

PONZI SCHEME

Lesson number two: Look beyond the surface, ask the right questions.

The investors were just greedy. At its peak Theranos was valued at $9 billion according to an internal valuation in 2014.

The company was already fudging accounts by inflating revenues and subsiding its “cheaper” pricing on its blood tests.

Theranos’ abundance of dollars allowed it to operate a Ponzi-like scheme where it could pay off made-up returns to older investors with new cash.

There is such a thing as over-funding a start-up.

CASH FLOW

Too much money does not allow the enterprise to operate sustainably.

Lesson number three should have been an obvious one to a financially savvy lot.

A healthy cash flow does not supersede a healthy profit and loss statement.

Yet another reason why the stockholders stumbled was their failure to recognise the inherent conflict of interest in the CEO and Founder also acting as the chair of the board.

CONNECTIONS

Holmes, wearing her key management and primary shareholder hats, failed to recruit a board that would ask the tough financial and scientific questions, preferring connections that would help secure lucrative government or military contracts.

Lesson number four – as the Ashanti say, one cannot both feast and become rich. Or put another way, a fox cannot guard the hen coop.

After the damning Wall Street Journal exposé in 2015, and faced with a host of resignations, Theranos took some action, including diversifying its board with some scientists.

It was too little too late.

DIVERSITY

The former top military and political leaders in the board behaved like sheep.

They followed Holmes’ bidding without question and failed to safeguard the interests of shareholders.

The board could have benefited from a few non-military or non-politician types from the beginning and perhaps someone would have the courage to say no or at least hold on.

The last lesson: Diversity is crucial for boards.

The superficial diversity of race, gender, ethnicity but most importantly the subliminal diversity of attitudes, viewpoints and thoughts.

BROCHURES

Taking it back to our Kenyan context. It’s a Friday afternoon and you receive that phone call from an unknown number.

The voice at the other end explains that your name has been put forward as a nominee for board membership — would you be interested?

Without too much thought your Pavlovian response is to answer affirmatively … Oh and can you send us your profile and can we add it to our website and company brochures?

You can also get shares…The cautionary tale is think twice.

Have you done your due diligence? Elizabeth Holmes’ net worth today is zero dollars and her reputation zilch.

The author is the Managing Partner of C.Suite Africa a boutique management consultancy. [email protected]