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Venture Capital, Lies, and Theranos

Last week, a jury found Elizabeth Holmes, the entrepreneur behind the biotech startup, Theranos, guilty of four counts of fraudulently deceiving investors.

What’s crazy is how sophisticated her 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.

Another company that underscores the necessity of due diligence in venture capital investing is WeWork, cofounded by Adam Neumann.

Today, we feature the latest issue of Venture Capital Digest from our private equity specialist, Cody Shirk. In it, Cody details the Theranos and WeWork stories.

It’s a fascinating read. I’ll let Cody take it from here.

Have a good weekend,

Jeff Remsburg

What We Can Learn from the Theranos and WeWork Stories

By Cody Shirk

They’re outspoken, big thinkers, natural leaders and a bit unpredictable. They’re extremely intelligent, a bit narcissistic and a force that won’t stop moving forward, no matter the obstacle.

I’m talking about entrepreneurs who possess the X factor. It’s nearly impossible to pinpoint, but successful venture capitalists know how to spot this winning combination of exceptional traits.

It’s rare to find someone who has what it takes to build something from nothing. The intelligence, creativity and enthusiasm required are given components, but it’s the ability to take on seemingly impossible challenges, all while keeping a cool head and big smile, that sets this rare breed apart.

While the methods of making it happen vary greatly, ultimately, successful entrepreneurs win by continually executing on their goal.

However, some entrepreneurs are more talented at selling a dream than they are at executing on their goal… and that can spell disaster for investors.

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

I’ll share these cautionary tales — and some tactics you can use to avoid making the same mistakes…

The Dream Seller Who Got Away

Standing 6-foot-5, Adam Neumann was the man who sold the dream of “working together and belonging” to some of the top VC and private equity investors in the world.

Neumann was able to make incredible finance connections as he built WeWork (NYSE:WE). Softbank (OTCMKTS:SFTBY), Harvard Management GroupBenchmark Capital and JPMorgan Chase (NYSE:JPM) were just some of the institutional-level investors that believed in WeWork.

Jamie Dimon, the CEO of JPMorgan, even served as one of Neumann’s advisers. This relationship and others enabled Neumann to raise over $11 billion in just under a decade.

WeWork’s initial business model was to rent large office spaces cheaply via long-term leases and then to rent small parcels of those properties to small businesses and individuals, particularly startups. The goal was a collaborative environment where ideas could be shared and made profitable.

Founded in 2010, WeWork grew to 390 locations by 2019, which was the same year that the company was scheduled to go public at a nearly $50 billion valuation.

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 for less than a $5 billion market capitalization. WeWork, which had far fewer locations and was burning money, was valued 10 times higher than Regus. Why?

From a 2019 Wall Street Journal article:

“The IWG comparison is also raising questions about whether We[Work] is worth what its backers say: IWG has been profitable for years and has a market capitalization roughly one-tenth of We[Work]’s $47 billion private valuation, despite reporting big losses.”

In the first half of 2019, IWG had made profits of about $60 million, 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 uncovered Neumann’s mismanagement and questionable personal activities.

For example:

  • JPMorgan provided Neumann with a $40 million line of credit for his personal real estate purchases.
  • As WeWork’s CEO, Neumann purchased $90 million worth of personal residences, including a 60-acre upstate New York farm estate, a 6,000-square-foot apartment in Manhattan, two homes in the Hamptons and a $21 million California mansion.
  • Neumann personally purchased commercial real estate that he then allegedly leased back to WeWork, funded by investors’ money. If so, this would be a clear conflict of interest — WeWork investors would literally be paying off Neumann’s personal real estate loans. Legendary real estate investor Sam Zell said these transactions “would never have occurred if WeWork was a public company and scrutinized accordingly.”

WeWork failed to go public in 2019, and Neumann stepped down as CEO in October of the same year. Securities filings show he received $245 million in company stock and $200 million in cash.

WeWork eventually went public in October 2021 through a special purpose acquisition company (SPAC) and today trades for around a $6.5 billion market cap. And even that valuation “defies belief,” based on a comparison to IWG.

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

It’s reported that he owns more than 4,000 apartments valued at over $1 billion altogether. According to a report from the WSJ, he plans to “to build a company that would shake up the rental-housing industry” and “create a widely recognizable apartment brand stocked with amenities.”

Clearly, Neumann is a master of selling a dream — of selling an idea. But he couldn’t deliver that dream… and investors lost a lot of money.

The Dream Seller Who Got Caught

Although you may not know the backstory of the private healthcare company Theranos, you’ve likely seen the name Elizabeth Holmes in the headlines recently. California jurors 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 found guilty on four counts related to defrauding investors and not guilty on all charges related to defrauding patients. The ruling is notable — the court ruled in favor of investors who lost hundreds of millions of dollars backing the startup 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 lure big investors.

Holmes graced the cover of dozens of major news outlets. Inc. magazine even labeled her the “next Steve Jobs.”

While it’s generally acceptable for entrepreneurs to pitch big ideas and sell dreams to investors, it’s unacceptable to falsify information — which Holmes did… extensively.

Theranos claimed to be able to run over 200 tests from a single pinprick of blood, all with a machine that could rest on a desk.

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

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

Board members included:

  • Former Secretary of State Henry Kissinger
  • Former Defense Secretary William Perry
  • Former U.S. senators Sam Nunn and William Frist
  • Richard Kovacevich, a former CEO of Wells Fargo & Co. (NYSE:WFC)
  • William Foege, the former director of the Centers for Disease Control and Prevention
  • Gary Roughead, a former U.S. Navy admiral
  • Riley P. Bechtel, a former board chairman of Bechtel Group Inc.
  • Jim Mattis, a former U.S. Marine Corps general (and soon-to-be Defense secretary)

It’s worth noting that none of these individuals will face any charges or repercussions (except maybe a slight ding to their reputation).

Ramesh “Sunny” Balwani, second in command at Theranos and Holmes’ onetime boyfriend, is due in court in the coming months. His case will likely go the same direction as Holmes’, considering that he aided her and the company in falsifying information to attract investors.

If you want to test your BS detector, you can listen here to a 2013 recording of Holmes pitching Theranos to investors. This specific call resulted in one investor upping his stake in the company by $5 million.

WORTH A WATCH: In 2021, the movie WeWork: or The Making and Breaking of a $47 Billion Unicorn was released on Hulu. HBO carries the documentary The Inventor: Out for Blood in Silicon Valley. They’re worth a watch for any private investor.

What Can We Learn?

Do your due diligence!

Of course, that’s easier said than done. Both companies — WeWork and Theranos — convinced numerous legitimate investors. But as all private investors eventually learn, anything can and will go wrong in the world of startups. It’s up to you to do your homework.

It’s easy to get swept up in the excitement of a new private opportunity. The fear of missing out (FOMO) surrounding hot new startups can cloud even the savviest investor’s eyes.

I’ve said it before, and I’ll say it again…

If a company makes implausible claims, demand proof. You can usually uncover much more than you’d ever think.

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

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

Article printed from InvestorPlace Media, https://investorplace.com/2022/01/venture-capital-lies-and-theranos/.

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