Energous, Theranos, uBeam Updates

I've been at the International Ultrasound Symposium in Kobe this week, and have hardly had time to do any updates or summaries of what's been going on in Energous, Theranos, and uBeam lately. Having spent the weekend walking around Tokyo, my feet are now sore enough that I'm going to sit still for a couple of hours and write. Let's start with Energous:

We last left Energous after an earnings call where finally someone questioned their basis for optimism, and they were promptly cutoff. Emperors do not like their nakedness pointed out. The other key takeaways from that call were that the long range transmitter was pushed out to 18 months away (again), and that hearing aid products would be out within 90 days. Well here we are 88 days later (which means another earnings call is coming up, Tuesday Oct 30th at 1.30pm PT), and what's happened?

First thing is that the share price seems to be on a long, slow, almost constant trajectory down, losing about $1.50 to $2.00 per month since April, and right now the after hours trading has the share price under $8, putting the company market cap close to $200 million. Not good for shareholders and compensation of employees, nor for any future share offering. Worse, given their revenues, >95% of their valuation is based on the hope of massive future growth - there might be a stock price at which the big institutional investors need to exit, and at that point it's game over. So what are they doing about it? I've indicated in the past that I expected to see some goosing of the stock price with pointless or small-time product announcements and so on, and those products were indeed announced. (BTW Energous, you didn't bother to check your website after the redesign - your "In the News" page is a bad link). 

First of all we have some asset tracking tags by Qubercom, though it seems it's the contact based charging, which kinda defeats the "IoT charging" wireless benefit when you have to drop 20 of them at a time on a charging pad. Seriously if you want to charge IoT low power devices wirelessly, there's already solutions like PowerCast out there. Then we have some spinal position trackers, also with contact based charging from the Gokhale Method, which I did try to buy, but the nice lady there told me they wouldn't be available until next year and only available to practitioners, so it's not really a big market. Apparently Austar Hearing have an upcoming product, but I can't find anything there. Now Energous have also passed regulatory approval for their contact charging in 100 countries (oooooh...), so you can imagine my shock when none of these had any effect on the stock price.

Pretty much, it seems everyone is wise to their games now. No stock bump just before Apple WWDC events, no belief that charging hearing aids is going to make them a $1 billion company. Without a major product release (not announcement), real regulatory approval for something practical, or clear licensing deal with a real company like Apple, this thing is heading to $0. Remember they are out of cash in Q1 2019 so they've less than 6 months to raise more money, and with a declining stock price that's going to be hard to do. Have we reached the limit of this game? I would say so, but the chutzpah of this company, and the gullibility of the press and the public, might mean there's another round left in it.

Theranos

CEO Holmes and COO Balwani of Theranos are facing criminal charges for fraud at the blood testing company. Earlier this month they lost an appeal to try to keep documents out of the government's hands, and according to Bloomberg the judge in the case referred to undisclosed charges and activities, while the Assistant U.S. Attorney bluntly stated that the indictment did not cover all the criminal activity, implying there may be more to come for the pair. Not looking good for them.

Marketwatch had an interesting article on "The Last Days of Theranos" and is pretty blunt with the sub-title of "the financials were as overhyped as the bloodtests". It covers a lot of the mechanics of what happened but the really standout parts for me were the statements from Daniel Warmenhoven, a board member from December 2016. It starts with this quote from him about one of the huge deals that "made" the company:

“The Walgreens deal made no sense, ... It was doomed from Day 1 because it was based on using the minilabs, which weren’t completed when the deal was signed."

So he immediately admits the whole thing was a fraud, but later comes out with this gem:

Warmenhoven told MarketWatch he blames engineers for the final sinking of Theranos. “They lost the recipe. The tests were not coming out right. That 60 to 90 days extra to figure it out took away the runway we thought we had.”

Yes, that's right - after terrible business practices, fraud, intimidation of former staff, 15 years work and over $700 million of investment, it comes down to two months and dumb engineers losing the Post-It with the entire future of the company on it. Damn those pesky engineers!

This seems to be the norm for people like Warmenhoven - engineers as annoyances, replaceable cogs that better behave, not a vital part of the technology development or company, but rather the true irreplaceable geniuses are the CEOs who are the innovators and aren't held back by such things as fraud, physics, or Post-Its. 

This ties with statements I've heard C-level execs make with all sincerity "I told the engineering team what they needed to do, they just didn't understand/weren't good enough". There's some school of MBA that says engineers are fungible units, and are lazy and always say they can't do it, and so need pushed. To an extent there's usefulness in pushing a team to achieve more, and then as a C-level exec providing them the resources, cover, and time to execute, but those without the training and experience seem to regard measured statements that something can't be done as demanded as more of the frustrating whining of a developmentally challenged child than of an experienced employee trying to do the right thing. The idea that the C-level is wrong or mistaken is clearly an option never to be considered.

uBeam

And so that brings me to uBeam. Only a couple of things to say here, there's really precious little new information on this. Mark Suster, the lead investor in uBeam, seems to have deleted all his Tweets from prior to October 1st this year, which is shortly after Perry "moved on" as CEO. He's been a prolific poster on many topics over the years, so this was surprising to see. Further, his Medium post supporting uBeam from just after my blog gained publicity, seems to have been altered. The article "What is it Like to Wake Up and Have the Press Ready to Torpedo Your Business?" used to contain the line:

“If for any reason we fall short of expectations we have set in the market, I will be the first person in line to admit it and then to immediately fund Meredith’s next company.”

for which Mark drew high praise - you can see references to it in the original blog comments, as well as articles from other investors here, here, and here - but at some point between original publication and now, that line disappeared. I wonder why it's not there anymore? (Thanks to HowardLong of EEVBlog for spotting this).

Last thing - I've been asked "What would you do if you were made CEO of uBeam today?" Here's my simple answer, and bear in mind I have not seen the status of the company or the books, I'm just inferring from public information:

I'd give the staff 60 days notice that their jobs were ending, and an offer of a bonus should they stay and tidy up their work (document, and pack it up), along with services to help find another job. Then I'd close down the company, and return the remaining money to the investors. In my opinion, it's the most they'd ever get back.

I'll be surprised if that happens as usually the "sunk cost fallacy" along with legal hurdles prevents such an approach, but I just can't see how the company is viable at this point.

It's Dead, Jim - Theranos Edition

Yesterday I posted pointing out the Theranos website was down, and wondered if that meant the company was defunct. Today, the Wall Street Journal confirms - Theranos to dissolve. From the article:

In the wake of a high-profile scandal, the company will formally dissolve, according to an email to shareholders. Theranos will seek to pay unsecured creditors its remaining cash in coming months, the email said. 

Most of Theranos’s two-dozen remaining employees worked their last day on Friday, Aug. 31.

All told, investors in Theranos have lost nearly $1 billion.

I think it's all been said in previous Theranos posts. Nothing more to add really. Now to see what happens in the court cases.

Is It Dead Yet? - Theranos Edition

A reader points out that the Theranos website can no longer be reached, it looks like it has been taken down. They had indicated they may be out of money (at least the minimum to meet contractual requirements) by the end of July. 

So is it finally an ex-Theranos? Most likely, yes it is.

Delusional Investors: Theranos Edition Part II

A couple of days ago I posted some videos of well known VC and early Theranos investor Tim Draper defending Elizabeth Holmes and calling SEC involvement "government interference" and saying that journalists were responsible for the downfall of the company, not fraud. Apparently it's a route to vast riches for a journalist, and so they can't be trusted, unlike the purely altruistic VC.

It's amazing how when talking about fraud in large organizations it's always the person who has least to gain financially that has their motives questioned, usually by those with most to gain. In part it's to cast doubt onto the messenger, but also the accusers simply can't understand any motivation other than financial for revealing wrongdoing.

Draper's now doubled down on his doubling down and even after federal indictments drop, he's saying the same. Watch the video. I really don't know what to say.

Billionaire investor and early Theranos backer @TimDraper discusses supporting Elizabeth Holmes after her fraud charges, how more journalists will try to take down CEOs to get rich, and why he's not soured on investing in young, visionary startup founders. #CheddarLIVE pic.twitter.com/fxXGJEgFZU

— Cheddar (@cheddar) June 19, 2018

Theranos CEO Elizabeth Holmes Finally Faces Criminal Charges

It's been some time coming, but the CEO of Theranos is finally facing criminal charges for fraud, as the WSJ's Carreyrou reports here. The indictment is a well-written history of the company and distills down to a few pages the scheme to defraud investors, doctors, and patients. The charges focus on Wire Fraud occurring between late 2013 and mid 2015, and of the 11 counts of Wire Fraud, one is for the defrauding of investors, one for defrauding of patients and doctors, six are for monetary transfers from investors, one for payment to advertisers for their products, and two are for wiring of patient blood test results. The pair face up to 20 years in prison, $250,000 in fines, restitution to the defrauded, per count. Holmes, and co-defendant COO Balwani, have both plead not-guilty to all charges.

Holmes settled civil charges with the SEC for "massive fraud" a few months ago, and some were upset that she was allowed to settle for a seemingly small fine ($500,000) and a  10 year ban from being a company director. With the latest charges, Holmes has stepped down as CEO, but somehow remains the board chair at Theranos. I've felt for some time that Holmes was going to jail for what she'd done, and that while the wheels of justice turn slow they grind exceedingly fine. I have the feeling up to 220 years in jail is a pretty smooth paste...

Wire Fraud is a common charge in such cases as it is relatively straightforward to demonstrate as interstate (for federal jurisdiction) and has been upheld by the Supreme Court as quite broad in covering "everything designed to defraud by representations as to the past or present, or suggestions and promises as to the future." Other courts have expanded this to "puts its imprimatur on the accepted moral standards and condemns conduct which fails to match the 'reflection of moral uprightness, of fundamental honesty, fair play and right dealing in the general and business life of members of society'".

Reading that wording, it's surprising and refreshing to see that 'caveat emptor' does not necessarily apply and that there is the expectation of fair dealing and honesty, even about the future. When discussing cases of fraud by startups, I often hear push-back that "everyone exaggerates", "they must have really believed so it was OK to exaggerate", or "well it's within the wording of the law even if they knew it was wrong". While startup and VC mentality may still accept that "fake it 'til you make it" is the norm, as with the SEC charges earlier this year, the law is making it clear that this is not legal, and that exaggeration as well as outright falsehoods are illegal. 

“The Theranos story is an important lesson for Silicon Valley,” said Jina Choi, Director of the SEC’s San Francisco Regional Office.  “Innovators who seek to revolutionize and disrupt an industry must tell investors the truth about what their technology can do today, not just what they hope it might do someday.”

The federal charges against Holmes and Balwani make this even clearer, with wording like "obtaining money... from investors... by means of materially false and fraudulent pretenses... and material omissions with a duty to disclose". If you know it won't work, and fail to disclose, that's going to come back on you too - it's not just what you say, it's what you don't say. Energous, in my opinion, are another example of this type of fraud, where they deliberately create confusion to sell people the hope of at-distance wireless charging, when they know the promised future will never come.

Next standout statement in the indictment, at least to me, was "represented to investors that Theranos did not need the Food and Drug Administration ("FDA") to approve its proprietary analyzer and tests". Given that so many startup companies rely on regulatory arbitrage, that is bypassing existing regulation "because it's tech", and operate in some very grey areas (see Uber's history), companies who have claimed to investors that no regulatory approval would be needed might want to rethink that kind of statement unless they are very, very sure.

One of the last aspects of the "scheme to defraud" that the indictment raises is "represented to members of the media for publication of the false and misleading statements described above, and shared the resulting articles with potential investors both directly and via the Theranos website, knowing their statements to members of the media were false and misleading." So exaggerating/lying to the press then using those articles as part of your fundraising is part of a fraud case? I've repeatedly argued that this behaviour is fraudulent and told that it is not, I'm glad to see the US Attorney agrees. Some startups may want to review their media strategy.

I don't think Silicon Valley have really internalized this yet, and will find ways to make Theranos an exception. How many more Theranos style cases do we need until there's no more denying that they are not the exception? While Holmes' behavior was particularly egregious, to me it was an inevitable outcome of a system that through funding bias regularly selects for the most morally-flexible personalities in their founders. If by funding choices you prefer your CEOs to be liars, don't be surprised when they lie.

I hope that this might be the start of at least some people realizing that if they heavily exaggerate, or try to fake it 'til they make it, regarding investors and customers, that it's not "being an entrepreneur", it's fraud. That being said, until those providing the funding alter their metrics to favor the honest, I don't expect to see any major changes.

For those wanting to read more on Theranos, I can highly recommend John Carreyrou's book "Bad Blood", my review is here.

Theranos: Holmes Fundraising for New Company, and Sociopathic Founders?

There was other Theranos news this week that was overshadowed by the indictment, coming in the form of a Vanity Fair article by Nick Bilton. In it he reveals that disgraced CEO Holmes is currently doing the rounds of VCs in Silicon Valley pitching her next startup, even before her existing company goes under. Yes, you heard that right. Despite everything, she's still actually getting meetings with investors willing to listen to someone with her reputation. Now, I have to admit that if I were an investor, and I got a pitch from Elizabeth Holmes I'd be tempted to meet her in person to see what she was like, even if I had no intention of funding anything - however when there are VCs like Tim Draper who still are convinced that Theranos would have succeeded if it hadn't been for those pesky journalists, you know at least some of them are genuinely interested. Beyond that, imagine the thinking of someone who just settled with the SEC for fraud, with an imminent fraud indictment, who can go out there and straight faced ask for investment.

Bilton hits on a couple of key points that I've been trying to raise in this blog - first that the way tech media, investors, and startups interact is broken and encourages dishonesty and malinvestment. While Theranos is presented as a particularly egregious example of a Silicon Valley startup misdeeds, anyone who has been involved in the scene for more than a few years can recognize many other companies in what happened. It is not an outlier, it is an inevitable consequence of the system of financial rewards that benefits the least scrupulous. To quote from the article:

"You would think that seeing Holmes’s duplicity wrapped up in a neat bow in Carreyrou’s book, and in the S.E.C. settlement—which, incidentally, mentions the term “fraud” seven times—would force Silicon Valley to perform its own due diligence, and question whether the way C.E.O.s, investors, and the media interact should be re-evaluated. But alas, the tech world doesn’t see Theranos as a tech company, but rather a biotech outlier. In Silicon Valley, you can be sure that the company that should have changed everything about the way business is run will actually change very little. The majority of the tech press won’t ask tougher questions of Zuckerberg or Musk; they’ll simply continue to fawn over the idols of the business world. Whatever they say must be true."

Traditional VCs are saying that they didn't invest in Theranos, and they are right in that, much came from wealthy family foundations, but the entire "myth of the founder" and ecosystem that each is partially responsible for birthed this monster. The tech press, who put her on the cover of magazines and called her "The Next Steve Jobs" simply didn't do any due diligence of their own, and blindly accepted her word without even bothering to call their local university biotech prof for a comment. You are starting to see, though, an increased skepticism in at least some of the press, with the better journalists and publishers questioning that bit more, after all who wouldn't want to be the next Carreyrou? 

The second point Bilton raises regards the character of those founders who receive the most funding and coverage - the go-getters who sell incredible visions and struggling against reality to deliver the future, or the snake-oil salesmen peddling dangerous cures for their own financial benefit - depending on individual case and your viewpoint. In the case of Holmes and others accused of fraud, what does it take to do this over multiple years?

In his book "Bad Blood", Carreyrou says of Holmes "A sociopath is often described as someone with little to no conscience. I'll leave it to the psychologists to decide whether Holmes fits the clinical profile, but there's no question that her moral compass was badly askew". While he goes on to say he believed she started the company with good intentions, it soon became evident there was to be no compromise in the vision, even to reality. "Her ambition was voracious and it brooked no interference. If there was collateral damage on her way to riches and fame, so be it." I'm not sure how else you can say that there is no conscience and guilt over the consequences of a person's actions. In his interview with Bilton, Carreyrou is a little more blunt: "She absolutely has sociopathic tendencies".

I think those of us who are "normal" simply want to dismiss that anyone could act that way, and there has to be a logical explanation for why they acted like that. Someone may set out with good intentions, but they are not made into a sociopath by the events in their life, their reaction to those events and their ongoing actions reveals their sociopathy. It's what they always were, it's just they're now in a situation that makes it obvious, compared to simpler times when the natural urge to think well of people lets us pretend they are a decent person.

Given how quickly Holmes showed a consciousness of guilt, it's clear to me these personality traits were already there. In "Bad Blood", the prologue relates that in 2006, less than three years after the company founding, CFO Mosley bluntly stated to Holmes "We've been fooling investors. We can't keep doing that." and for doing his job she immediately fired him. There are countless other examples where it's clear she knows she's doing wrong. Perhaps she believes that in the end she'll be proved right and that the end justifies the means, but that still doesn't absolve her of her wrongdoing. Regardless, she was this way at least 12 years ago, it is not a recent change.

While we've been talking sociopathy, I'm going to lay out an alternative lay-person diagnosis. Take it as my opinion, my Ph.D. is in engineering, not psychology. Bilton's article has a key quote:

“One person in particular, who left the company recently, says that she has a deeply engrained sense of martyrdom. She sees herself as sort of a Joan of Arc who is being persecuted,”

Now this may be a mask she wears to fool others, but I think this is a narrative that she has developed to explain her actions and justify them to herself. Everyone is the hero in their own story, and needs that narrative to define their life and why they are not the villain. From when the first stories broke on Holmes in 2015 the response was "misogyny", and even today her backers such as Draper claim persecution. A sociopath, typically suffering from a lack of empathy, simply wouldn't care. They might use such stories to provide cover for their actions, but not actually believe them. A person with other psychological issues, but not sociopathy, would build an elaborate tale of persecution to validate themselves rather than admit their wrongdoing. If any such issues are to be looked at, in my opinion it's the various parts of Personality Disorder Cluster B. According to the American Psychiatric Association, it is possible to meet the criteria for multiple disorders. Highlighting the four cluster components:

• Antisocial: a pervasive disregard for the law and the rights of others.
• Borderline: extreme "black and white" thinking, chronic feelings of emptiness, instability in relationships, self-image, identity and behavior often leading to self-harm and impulsivity.
• Histrionic: pervasive attention-seeking behavior including inappropriately seductive behavior and shallow or exaggerated emotions.
• Narcissistic: a pervasive pattern of grandiosity, need for admiration, and a lack of empathy.

Someone who has a disregard for law and others, sees in extremes, attention seeking, grandiosity, and a need for admiration. Does that sound familiar? Now you can still make a case for either, but for an attention seeking, billion dollar startup founder, the narcissistic trait in particular is too good a fit, and one that seems to be pretty useful in raising money.

Delusional Investors: Theranos Edition

If you want to see Tim Draper, early Theranos investor, defend Theranos against all reality, just watch this interview. It's about 11 minutes long, and he comes out with multiple statements that are flat out wrong. To capture just three of them:

• The SEC charges were based on innuendo: False, the SEC charges were detailed and Holmes settled them. She was accused of "massive fraud" and the SEC were very clear about that.
• The SEC has no authority to regulate non-public companies: False, the SEC absolutely have authority to enforce fraud laws on non-public companies. To quote “The charges against Theranos, Holmes, and Balwani make clear that there is no exemption from the anti-fraud provisions of the federal securities laws simply because a company is non-public, development-stage, or the subject of exuberant media attention.”
• Carreyrou's book Bad Blood is nothing but lies: False, read the book and his articles, they are meticulously researched with detailed interviews and documentation. Had they been malicious lies, Theranos and Holmes would have had an exceptionally strong case to sue for libel.
• Theranos had a viable product, it was just 'beta': False, not even close. They never had anything even close to working at a level acceptable for medical diagnosis.

This is the guy who is campaigning to split California into three states, which makes as much sense as Theranos being a viable company. I'm not sure if he still genuinely believes in Holmes, or just so unwilling to admit he was a mark in a con that he's doubling down.

There's another similarly crazy interview here. 

Bad Blood: The Story of Theranos

As long time readers of this blog know, Theranos is a company I've been covering since my very first post over two years ago. I'd been somewhat familiar with them since around 2013/14 - living in Silicon Valley and knowing many people in the biotech business there had always been rumors floating around as to exaggerated results and occasionally even faked demos. They were such an extreme example of what I've seen in startups over the last ~20 years they were a perfect vehicle for my blog to help highlight what was going on. 

The Wall Street Journal's John Carreyrou had reported 'questionable practices' at the company at the end of 2015, and despite heavy handed legal threats and constant denials by Theranos, things quickly started to unravel for the company and it's expected that the company will be bankrupt this summer, with possible criminal charges for the CEO, Elizabeth Holmes, to follow. Carreyrou has now written a book about Theranos called "Bad Blood", and covers the company's founding through to the present day. It was originally scheduled to be released later this year, but brought forward several months due to the impending bankruptcy of the company.

While I have followed Theranos closely, and know the facts of what's been happening better than most not directly involved, this is still a fantastic book that I both enjoyed and learned a few new things from. Despite it being a complex story of technology and finance, Carreyrou breaks it down in a straightforward way that anyone can follow, regardless of background. No need to understand tech or funding mechanisms - as long as you know what cheating, lying, and bullying are then you'll follow along without a problem. It's also Silicon Valley in a nutshell, and on almost every page there was something that reminded me of my own personal experience in startups, or those of close friends. I'd highly recommend it to anyone with even a passing interest in the story.

What I came away with was not what I was expecting though. I had thought that Holmes, and to a lesser extent, her boyfriend and company President/COO Sunny Balwani, would be the villains of the book, and the central characters it was built around. In the end, the memorable characters for me were the many employees who tried, over a period of nearly ten years, to draw attention to the fraud and dangerous actions of Theranos, even in the face of significant costs, both personal and financial. Many of them have suffered tremendous stress, such as through huge legal bills in the case of Tyler Schultz, or the death of a spouse through suicide in the case of Rochelle Gibbons. Despite threats of a lawsuit and being followed by private investigators, Erika Cheung wrote a complaint to the federal government that initiated lab inspections, shutdowns, and reports that sped the demise of the company. They didn't do it for profit, or because it was fun, or that they had an axe to grind, but because they knew what was going on was wrong, and someone needed to do something. Were it not for them, we'd be finding out about Theranos years later when people were dying through misdiagnosis and either lack of treatment, or incorrect treatment.

Even more frustrating was reading that those with the power to have done something failed to do so despite more than adequate evidence to do so. In 2008 the Theranos Board of Directors was warned of what was going on by both the head of marketing and the general counsel, yet something that would otherwise have had the CEO removed resulted in the removal of the whistleblowers instead. Many Board members of startups fail to take their jobs seriously, thinking it a once-a-quarter paid trip to California, and an important sounding line on their resume. Ultimately, they do have a fiduciary responsibility to the shareholders of the company, and I hope some of them see legal consequences for their actions - though I'm not holding my breath. Until that happens, I don't see the lack of oversight changing soon.

Senior management of both Safeway and Walgreens should also be ashamed of themselves - even when warned by their own due diligence consultant that something was very wrong with Theranos, Walgreens listened to Holmes and essentially had him removed. In any other deal I've ever been part of, should the person performing the due diligence be denied basic information and access then that would have been the end of the deal. Safeway spent $350 million doing up their stores with fancy "wellness centers" that were supposed to have been for Theranos - notice those nice wooden offices next to the pharmacies in your Safeway? That's what they were built for. They ignored the suspicions of their own chief medical officer and went on with the deal anyway.

Tech and business journalists also share some of the blame - like in too many cases, they simply accept the word of the company as to the state of their product and business, and fail to ask even basic questions. I've pointed out repeatedly on this blog how tech journalists are used in a 'whitewashing' of company PR, even when many experts are available to quickly debunk the most ridiculous of claims. It wasn't until Carreyrou came along that the serious questions were asked. Journalism like that doesn't come cheap though, and is a reason I subscribe to the WSJ, and I'd encourage you to do so as well.

Time and again the warning signs were there, and were raised by 'coal face employees' at all these organizations, only to be ignored by those at the top. Everyone looked at the glowing endorsements by the big names like Henry Kissinger or James Mattis, while ignoring the stream of people who knew what was going on and leaving their jobs in droves. Something I've always felt is that if you really want to know what's going on at a company, don't speak to the executive team or board, speak to the senior employees who actually make everything run - and if you can't speak to them because they keep quitting, then that's a huge red flag right there.

My first post on Theranos concluded with the quote below, and time has only strengthened my opinion:

"To be blunt - technology has gone beyond the capacity for most people to be able to comprehend, even some otherwise very intelligent and educated ones. That deluge of information 'overloads' most people and they fall back on the simplest of solutions - they look for authority figures who have already made decisions for them, or rely on the 'wisdom of crowds' and simply go along with the majority. Actual reasoning shuts down, and following that the idea that someone as smart and educated as you could have got it wrong just can't be entertained (or in the case of existing investors, ever acknowledged).

Something needs to change in how billions of dollars of funding, much originating from retirement funds, is distributed. The system is setup to reward certain behaviours, and good stewardship of this money, and the efficient application of efforts of thousands of workers to benefit our society, in my opinion are not among them. 

Theranos, and others like it, were simply inevitable and the symptom of a much deeper problem."

Theranos is all the flaws of Silicon Valley VC and startup culture bundled together and then cranked up to 11. Lives were ruined and even lost, over a billion dollars spent, and has it even changed anything? Even when federal agencies were admonishing the company for its practices ("massive fraud"), a VC complained publicly that was just the business model of every startup they'd been involved in. How many people have to die before some realize that funding a dating app is not the same as medical devices, and that lives are on the line? We'll see what criminal charges are forthcoming, but in the end the story of Theranos is just that of many Silicon Valley startups, "fake it 'til you make it", they just pushed it too far and got caught.

Theranos Updates - Loan defaults, layoffs, bankruptcy, and mega-rich families burning half a billion dollars.

Last month Theranos were back in the news, barely a few weeks after being admonished by the SEC for using lies and exaggeration to raise over $700 million from investors, this time for the CEO to announce that they were running out of cash and would likely have to close by the end of July. Approximately 100 employees will be let go in early June, leaving less than 25 who will most likely oversee a winding down of the company.

Theranos received a funding round last December, with a $100 million loan from Fortress Investment Group, which had many had been shocked to hear given the widespread knowledge of the company's difficulties. In my December article I pointed out things likely weren't as they seemed at first, and this was simply a predatory loan made in the knowledge that Theranos would in fact default, and that the lender would then take ownership of the company assets at firesale prices.

"So Fortress have arranged a deal where they don't have to put the full amount in up-front, but are still ahead of any other investor, get to own the only valuable part of the company if it goes wrong (the IP), and get discounted stock in the company if it, through some miracle, succeeds. With the right milestones and triggers, this could be a deal where Fortress win no matter what happens, and may actually come out better should Theranos fail. I wonder if Fortress have essentially arranged a deal to make sure that all the good parts are gone by the time everyone else reaches the bankruptcy auction.

Why would Theranos take such a deal? Well, because they have to choice - it's this or bankruptcy."

Well I'm feeling pretty smug right now, as that's exactly what looks to have happened. According to a letter Holmes wrote to shareholders (included at the bottom of this post, from Buzzfeed), despite having received $65 million from Fortress in December, they're about to miss a deadline for FDA approval on a device which will result in them not receiving the next tranche of $10 million. Most significantly though, should Theranos' bank balance drop below $3 million, they are in default of the terms of the Fortress loan, and the company predicts that will happen in July. According to Holmes:

Fortress would be entitled to control a foreclosure sale and/or monetization of the assets and to realize up to a three-times return on its investment (including, in addition to the amounts loaned by Fortress, the costs associated with Fortress’ monetization of the company’s assets). 

So Fortress get three times what they loaned, including whatever legal costs they have in extracting this money. A factor of three on the loan plus costs means they won't just get most of the company, they'll get all of it.

That $65 million gets Fortress around 1,175 patents (granted and applications) in the biotech space. They can sell them, licence them out, or use them to sue other successful biotech companies for payment. Given some large patent infringement payouts can result in 9 figure cheques, a single win like that will result in a great payday for Fortress.

It may not have even cost Fortress $65 million. I do wonder if they invested saying something like "This money cannot be used for legal expenses. It must be kept separate from all other cash and used only for salaries, facilities, and equipment." Knowing that Theranos had legal troubles they may have wanted to ensure the cash was not spent on that, and then set a stipulation that if the "other cash" account dropped below $3 million, the company essentially became theirs - regardless of how much of the investment was left. $65 million gone in basically 6 months, for a company of 125 people, is a monster burn rate. Even at a fully burdened cost of $400,000 per employee that's 'only' $25 million spent in 6 months. Facilities etc can be expensive, but not $40 million worth. In that case, Fortress would be owed $195 million (3*$65m), take the ~$40 million out the bank account that remains, then start picking the best $155 million of assets left (pretty much everything else) - making the cost of the whole company $25 million. Or maybe I'm just thinking too hard and Fortress didn't care, and just let them burn through it all with legal fees, thinking $65m was still a bargain.

Regardless, barring a miracle, Theranos are headed for default on their loan, and will end up being fully owned by Fortress. TheCEO amusingly asks for further investment to stave this off, but with the SEC judgement, and a skeleton staff, it's not going to happen. It will be interesting to see how Elizabeth Holmes does without the company to pay bills for her, such as for bodyguards, and with a likely criminal lawsuit coming. 

An Idiot and Their Money are Soon Parted

So who are the investors that Fortress jumped ahead of in their deal? Who put in the $700 million that got the company to this point? The Wall Street Journal recently published a list of major investors in Theranos, and it's now clear that the company was funded mostly by individual family investment vehicles, not traditional VC. Key investors were:

• Walton Family $150 million
• Rupert Murdoch $125 million
• DeVos Family $100 million
• Cox Family $100 million

So nearly half-a-billion dollars from four family investment groups, and they will probably see nothing back. (Murdoch already got out for a grand total of $4 million, a 97% loss). Pretty stunning, that. Now I'm going to bet on how much due diligence these companies did before investing, and I'm going with a number near zero. It was widely reported in March that when Theranos claimed revenues of over $100 million to investors, no audited accounts were provided, and investors failed to call a single supposed customer - and the actual revenue was $100,000. That's pretty basic due diligence that even the technically illiterate can understand. Think about the scrutiny you get when you go to the bank for a loan, and then realize that for $475 million no-one even picked up a phone and asked for a reference or a bank statement.

As for technical due diligence, they could have found a few well qualified scientists and executives in this area, and paid them a few thousand dollars each for technical and business evaluations. Total cost, less than 1% of the investment, but nope they couldn't do that either.

I've got no sympathy for them, they deserved to lose that money through their own carelessness - it's just frustrating that there are so many genuinely great companies out there that could work wonders on just a few million. That ~$500 million could have funded >100 hardware startups to a prototype/proof point, and made some genuinely useful advances - but the people that run those types of companies don't lie like Holmes, or exaggerate their technology, just to get a cheque signed (or, as in Holmes case, have well connected parents).

One bright side for Silicon Valley VCs, they can now say "See, wasn't us!", they really weren't the ones funding most of this decade's biggest fraud.

We'll definitely be hearing more about Theranos in the coming months, with the June layoffs, the July default, the inevitable bankruptcy and the possible criminal charges, but next up is John Carreyrou's book "Bad Blood". He's the WSJ journalist who broke the Theranos story, and his book is a history of the company, and will be out in two weeks (May 21st). My copy is on order, and looking forward to it. I fully expect a tale of insanity, greed, selfishness, and stupidity, and I'll review it as soon as I read it.

Holmes' Letter to Theranos Shareholders

April 10, 2018

Dear Theranos Stockholders,

We last wrote on December 22, 2017, shortly after closing a secured debt financing transaction with Fortress Investment Group. We said that the transaction provided us runway to continue work on the miniLab and to position the company for additional financing events—but acknowledged the narrow path forward.

Unfortunately, we are behind schedule on our first product milestone under the Fortress loan, and as a result will soon face a cash shortage. Below we detail our situation, apprise you of our options, and ask for your help as we continue to work to realize value for your investments. As we describe below, we are evaluating parallel paths, including potential investment terms that would provide a large stake in the company at what we believe to be a favorable price.

*****

The Fortress financing, which closed on December 11, 2017, provided Theranos with up to $100 million of liquidity, subject to product and operational milestones. The first funding tranche of $65 million gross was released at closing. The release of a second tranche of $10 million gross was contingent upon FDA approval or CE marking of the Zika assay for use on the miniLab. Achieving that milestone within the first half of 2018 was crucial to our business plan.

Development of the Zika assay has taken longer than anticipated. While the miniLab hardware and software have progressed steadily since we last wrote, we continue to face issues with the reliability of the Zika assay chemistry itself. As a result, timing for finalization of our FDA submission remains uncertain. We have raised with Fortress the possibility of releasing the second tranche of funding despite the lack of regulatory approval, but its willingness to do so is not assured and we understand that in any event it will likely depend on our securing additional commitments from our existing investors.

These developments leave the company in a difficult situation. Taking into account the substantial cost-cutting measures we are implementing today, including the reduction in force described below, our best current projections indicate that—absent further funding—our cash reserves will by the end of July fall below the $3 million minimum liquidity threshold required by the Fortress loan. Under the terms of our credit agreement with Fortress, our failure to maintain this minimum liquidity would constitute an event of default. Such an event of default, or other events of default that may accompany the company’s decreased liquidity, could precipitate an exercise of remedies by Fortress, including Fortress’ taking full control of our assets to satisfy the company’s obligations to Fortress. We expect that path would negatively impact the amounts, if any, available for distribution to our stockholders.

To avoid or delay a default under our credit agreement, we intend to take every step we can to preserve our remaining capital. Accordingly, today we provided notice, consistent with the WARN Act and other applicable law, to all but a small group of employees that their jobs will terminate in 60 days, on June 11, 2018. Difficult though that action is, we estimate that the associated cost savings will help conserve capital sufficient to fund our operations through approximately the end of July, without default under our credit agreement. After June 11, our remaining staff will consist primarily of financial, legal and administrative personnel alongside a core technical team, who will dedicate their efforts toward generating the maximum near-term return achievable for our stakeholders, likely through a sale of the company or its assets.

The most viable option that we have identified to forestall a near-term sale or a potential default under our credit agreement is further investment by one or more of you. In light of where we are, this is no easy ask. However, given your support of the company over the years, we wanted to provide this opportunity before we proceed too far down the current path.

Of course, even with new capital, the future of the company would remain highly uncertain. Nevertheless, additional investment may come with some meaningful benefits. A further investment could help protect your current one by providing the company time to continue developing the miniLab and/or to monetize its patent portfolio (subject to the terms and conditions of the Fortress loan). Further investment could also help us to avoid a sale for an uncertain amount—including a foreclosure sale following a liquidity-based default under the Fortress loan. Any such sale could significantly diminish the net realizable value of our assets. Moreover, in certain scenarios, Fortress would be entitled to control a foreclosure sale and/or monetization of the assets and to realize up to a three-times return on its investment (including, in addition to the amounts loaned by Fortress, the costs associated with Fortress’ monetization of the company’s assets). As a result, those scenarios would significantly reduce or eliminate any prospect of distributions to the company’s shareholders.

Our patent portfolio—which provided substantial support for the Fortress financing—contains more than 1,175 granted or pending patents worldwide. We believe our patents cover broad and important technologies, including: (i) the core technologies in the miniLab; (ii) technologies underlying point-of-care devices currently on the market and generating sizable revenue; and (iii) still-emerging technologies, such as an ingestible digital sensor that recently received regulatory approval for use in monitoring medication compliance. We also believe these patents have the potential not only to eventually protect the miniLab, should it receive FDA regulatory approvals, on the market, but also to support a licensing campaign that could generate significant additional revenues.

We have real progress to build on. Having rebuilt our quality system and implemented process-oriented safeguards for development and manufacturing, late last year we were granted a California Manufacturer’s License following an audit of our manufacturing facilities. Last month, representatives of a third-party notified body conducted an audit of our Quality System; we understand that the auditors will recommend issuance of the ISO 13485:2016 and MDSAP (Medical Device Single Audit Program) certification for the Theranos Quality System. We have also engaged a financial auditor, which expects to complete work on an audit of our 2017 financials by the end of June.

We recognize that the vision of distributed laboratory testing is what inspired many of you to invest, and we strongly believe that continuing our work toward that end could increase the near-term value of the company, and could provide the basis for building significant long-term value.

Although not yet set, the investment terms we are considering would provide a large stake in the company at a favorable price, in light of what we estimate is the intrinsic value of the company’s assets. We expect that new investment would take the form of a senior class of preferred stock, which would also feature substantial governance rights, allowing participating investors a significant role in steering the company forward.

Please note that if we offer new equity securities at a price per share less than the applicable conversion price of our existing series of preferred stock, the resulting anti-dilution adjustments could cause significant dilution to our existing stockholders. Such an offering would likely require the consent of the holders of a majority of our existing Series C-1B and Series C-2A Preferred Stock. The interests of these stockholders, who are senior to all other classes and series of stock with respect to payment upon a liquidation or deemed liquidation of the company, may differ from holders of other classes or series of our stock. Holders of Series C-1B and Series C-2A Preferred Stock should also be aware that their failure to participate in a financing having a purchase price of less than $5 per share would result in mandatory conversion of their shares into nonvoting Series C-1B* or Series C-2A* Preferred Stock.

Subject to our compliance with the preemptive rights of certain investors, we will offer this opportunity to all stockholders who are accredited investors within the meaning of Rule 501(a) under the Exchange Act of 1933, as amended. For any accredited investor who is interested in exploring it, we can provide a term sheet and are available to meet at any time. Irrespective of your future investment intent, we value your engagement as stockholders and welcome your questions and comments.

*****

This letter and its contents are confidential. We request that you not share or discuss this letter with others, except your attorneys, accountants and other advisors bound by confidentiality obligations. The unauthorized disclosure of this letter could violate the terms of agreements between you and the company, and could additionally depress the amount realizable upon a sale of our assets. This letter shall not constitute an offer to sell or the solicitation of an offer to buy securities, nor shall there be any sale of our securities in any state or jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or jurisdiction or a valid exemption therefrom. Any offering that we conduct will be made only to accredited investors and only pursuant to definitive offering documents, including a disclosure package.

Thank you again for your support.

THERANOS, INC.

Elizabeth Holmes

Chairman and CEO

Theranos - Will VC Change Following SEC Charges?

Those of you following any tech news will have read the major announcement by the SEC yesterday, that charges Theranos, its founder/CEO Elizabeth Holmes, and former President Ramesh Balwani with "massive fraud". To quote: 

"raising more than $700 million from investors through an elaborate, years-long fraud in which they exaggerated or made false statements about the company’s technology, business, and financial performance."

While originally a darling of Silicon Valley and the media, Wall Street Journal's John Carreyrou exposed their fraud in 2015. This resulted in vehement denials from the company, threats of litigation, and vocal support from prominent valley investors such as Tim Draper. The announcement from the SEC vindicates Carreyrou, and highlights the value of high quality investigative journalism, along with publications that stand by their staff, to society.

Holmes has been stripped of much of her stock, barred from serving as an officer of a public company for 10 years, has to pay a $500,000 fine, and loses voting control of the company. Further, she cannot make any profit from the company until over $750 million has been returned to defrauded investors and shareholders. Holmes did not admit any wrongdoing and will not, from this complaint, face jailtime. Balwani faces charges in federal court.

To summarize, for defrauding investors she will lose the financial benefit of that fraud, lose control of her company, pay a fine, but nothing more. The SEC pursues civil actions, while the Department of Justice pursues criminal charges, so jail time is still possible for jeopardizing the health of millions of patients with under-performing blood-tests that informed diagnoses and treatments, among other things. 

There's also no word on what this means for those directly impacted due to Theranos' aggressive legal tactics against those who raised the possibility of fraud. Tyler Schultz, the original whistleblower on the company, incurred over $400,000 in legal costs defending himself against what are now clearly valid claims of fraudulent behavior. It's a clear message to any potential whistleblowers out there - keep your mouth shut if you don't want a lifetime of debt to be the reward for your ethical behavior. Hopefully there is a civil suit coming from Mr Schulz that results in the company fully compensating him, and more, for these actions.

I've been writing extensively on Theranos since 2016, mainly to use them as a clear example of how the system of venture capital is in many ways broken - that the entrepreneur community is responding to incentives from those with money, the VCs, to tell them what they want to hear in return for that funding. While there are many ethical and diligent VCs, there are those who do not rise to those standards - and what they want to hear is not realistic development of a product that will produce a solid company and return them 5 to 10x investment in 5 years, but a 'disruptive' technology that will 'change the world' and get them 100x return in 2 years. Investors need to realize that by funding the most fantastical and improbable, that the realistic and viable are often crowded out and never see the light of day. There's millions of dollars at stake here, with a bias to reward those who paint the rosiest picture despite reality, so it's no surprise that those willing to push the limits of truth are found in high numbers. This final point was addressed head on by the SEC in their release:

“The Theranos story is an important lesson for Silicon Valley,” said Jina Choi, Director of the SEC’s San Francisco Regional Office.  “Innovators who seek to revolutionize and disrupt an industry must tell investors the truth about what their technology can do today, not just what they hope it might do someday.”

If that wasn't a direct enough statement to Silicon Valley that they should be aware that small startups seeking to "fake it 'til they make it" are not too small to be of notice, they also made sure to say:

“The charges against Theranos, Holmes, and Balwani make clear that there is no exemption from the anti-fraud provisions of the federal securities laws simply because a company is non-public, development-stage, or the subject of exuberant media attention.”

I had hoped that the Theranos story would result, finally, in Venture Capital taking a long hard look at itself and re-evaluating its model. In Theranos they would realize that the "Move Fast and Break Things" model that seemed to work in social media just cannot be applied to hardware, and healthcare in particular. That they would realize that yes, they were responsible for providing the system of rewards, and failing to provide a system of checks, that would encourage those willing to represent where they might be able to eventually go, as where they actually are. Is the attraction of investing in the next Uber, with all the questionable legal activities too, now something to be carefully considered, or is it a "no-brainer"?

Sarah Cone of Social Impact Capital Tweeted what I feel was the most appropriate response I have read:

I don’t need the companies I invest in to be perfect, but I do need them to be honest about where they are at. Confusion in the deck between where the company could be and where it’s at (happens often) gets an immediate pass. I want to invest in founders that I know can fundamentally see reality.

Which is exactly the behavior any VC should always have exhibited, and I was very glad to see. If I were a Limited Partner, one of the people who puts money into a Venture Capital fund and expects returns, it's the ethical and pragmatic behavior that I would expect.

What about other investors? Maya Kosoff of Vanity Fair spoke to multiple investors for their reaction. Some blamed the company, investors, and board members for not doing their job. One said that the temptations to cut corners and grow quickly were so large that may have led her astray, while another went further and explicitly said that investors were part of the problem.

“I actually think that the V.C. business model has changed and encourages this type of behavior."

While these investors all seemed to say there was a problem at least somewhere in the system, not one went one the record and would be named. Even when there is a statement from the federal agency charged with overseeing investment that there has been massive fraud, a reporter can't get an investor to put their name behind a bland statement like "This is a terrible black-eye for the industry and we should revisit our practices to ensure this never happens again".

Some were unhappy with the SEC action and were willing to put their name to that. Here's part of the reaction from Paul Kedrosky of SK Ventures, also on Twitter: 

"Many of the things the SEC is whinging about in its complaint will seem painfully familiar to any longtime startup investor or founder - did that! did that! did that! -- and everyone forgets them if you go bust, or you get bought/big.

I'm no Theranos/Holmes fan, but if the SEC is going to start banging startups for hubris and for getting their promise cart before their product horse, well ... let's just hope Steve Cohen does something wrong and distracts the SEC from startups first."

Now I have to wonder that if the federal government came in and enforced massive legal penalties on what I consider "standard operating procedure" of my industry, I might start taking a long hard look at my industry practices before saying it's just "whinging". Clearly this behavior is so endemic in the industry that even an egregious example can't make some sit-up and say "Maybe we should review our practices?". Moreover, I wouldn't be sitting admitting that I or any of my investments had been repeatedly guilty of committing many of the acts that had just been found illegal!

Kedrosky makes valid points that investors have a burden of due diligence (more, it's a fiduciary duty to their Limited Partners) and if they didn't do that, then more fool them. When pitching to investors in the past I have been prompted by them to increase my financial projections again and again until I literally told them "You know it's unrealistic, why are you telling me to say that?" and the answer was "It's not your job to tell me what's reasonable, I want to know what the biggest upside is, and then I'll decide". And they are right - it's up to them to do the due diligence, and decide the level of risk they are willing to take - but in part that due diligence depends on how much the startup is willing to 'exaggerate'. 

That "exaggeration" has been the norm for so long that it has moved from "painting the most positive picture facts allow" to "claiming what you wish were possible as the current baseline truth", and now it's simply accepted in the community. Like seeing an alcoholic waking after their latest blackout saying they'll never drink again, most sober people watching are skeptical. It seems that, at least in private, the investment community knows something went badly wrong here, but are some convincing themselves this was a 'one-off' and return to their old ways the next time someone offers them a 'drink'? 

And there is the problem - as long as there are "Ubers" out there, who, in the opinion of many, managed to use breaking the law to grow so quickly they could afford to fight the legal actions, there will be investors willing to put money in and turn a blind eye. Until there are criminal actions against board members, or VCs themselves, for failing in their fiduciary duty, I'm not sure there will be real significant reform. I hope I'm wrong.



Addendum: I'm going to add responses from other VCs to this as I find them. Searching online three days after the announcement, and either people are keeping their heads down, or my Google-fu is not what it used to be.

Here's Bilal Zuberi of Lux Capital:

"Big lesson SV can learn from Theranos: Don't peddle bullshit, and don't allow others to peddle bullshit. Don't lend credibility to people and ideas you know nothing about. And call out fraud when you see it."

Prominent Silicon Valley VC Tim Draper declined to comment to the press. Previously he had been a vocal supporter of Theranos, even as evidence mounted of "exaggeration". In 2016 he said:

"Taxi companies attacked Uber. Hotels attacked Airbnb. Car companies attacked Tesla. Telecoms attacked Skype. Fortunately for humanity, the transformative technologies made it through the attacks and we are all better off. They should be ashamed to try to take down this woman who is trying to do so much for health care. ... She should be hailed as a hero"

Theranos gets $100 million funding - is it what it seems?

Few things surprise me in the funding of startups anymore - when you see a juicer that gets $90 million that's pretty much the end of shock as to what gets money - but this week saw my jaw drop on the funding news front as Theranos, the supposed blood testing company, received a further $100 million. This scoop was from Lydia Ramsey at Business Insider, and follows John Carreyrou of the Wall Street Journal who did fantastic investigative journalism on Theranos over the last few years. Theranos are pretty much the poster child for what's wrong in tech investing. Here's a quick summary of why not to invest in Theranos:

• The technology never even vaguely met the wildly exaggerated initial claims
• Sued by investors to the tune of >$100 million for fraud (settled out of court)
• Sued by biggest customer for around $140 million for fraud (settled out of court)
• CEO/Founder banned by the federal government from running their main business line 
• Sued by Arizona AG for inaccurate blood tests on >100,000 patients
• Never/rarely subject their results to independent third party scrutiny
• Placed the safety of patients at risk
• Ongoing US Attorney and SEC investigations

Essentially, they're not "good actors" in any sense of the word - they've had to be sued by both investors (nearly unheard of) and customers, and risked the lives of patients with their blood tests. Why would you give them money? I don't think I'm alone in my initial stunned reaction, from what I see and hear the VC community is also pretty shocked by this one, even they don't want to go throwing good money after something this bad. After a day or so though, I began to think about it more, and I've come to the conclusion that it's unlikely that Theranos will ever see that full $100 million, and instead it's a savvy play for IP from a private equity firm.

The history

I've written fairly extensively on Theranos, but have not posted in over a year because I thought they were pretty much dead and the story was on hold until they went into bankruptcy or criminal prosecutions began. More fool me. A quick summary for those who haven't been following - Theranos claimed to have revolutionary blood testing technology that would identify many diseases from a  single fingerstick drop of blood, and raised >$750 million from VC (mostly non-traditional for biotech ones), had a board full of ex-government bigwigs including current Secretary of Defense Mattis, and had a Stanford dropout young CEO who the press loved. In the end it turned out to be a fraud, the technology could not do what they claimed, used heavy handed legal threats against whistleblowers and media, had to refund nearly $5 million to 76,000 patients for inaccurate blood tests, had the CEO/founder banned from operating a clinical lab for two years by the government, and eventually were sued by both customers and investors for huge amounts of money (estimated at over $100 million in settlements so far). There are ongoing US Attorney and SEC investigations, and likely other federal criminal investigations too. Having gone through some rounds of layoffs amounting to over half the company, everyone was just waiting for the bankruptcy filing and then the news of this funding dropped.

The investor

The investment comes from a group who often invest in 'distressed' companies - Fortress Investment Group LLC - that is they look for bargains and drive hard deals with companies desperate because they have nowhere else to go. There's a good history of the company here, and if you want to see a financial company where the executives make ungodly sums of money whether they succeed or fail, this is it. The five top executives took home near $1.7 billion just before they IPO'd in 2007, after which the stock plummeted by around 75% (at one point by 97%). 

The group had a turnaround earlier this year when SoftBank agreed to buy them for $3.3 billion, no doubt giving another payday to the executives at the company. For those who aren't aware, SoftBank runs the world's largest investment fund, the $100 billion "Vision Fund", and have made enormous purchases and investments such as to chip maker ARM Holdings for $32 billion, and Uber for $10 billion.

This is not a company where they invest in good social works or for the sake of humanity, they're in this deal because they smell money.

The investment

$100 million is a lot of money, even for a sizable company like Theranos. Seeing that kind of investment in a fraudulent company raises anger in those who have diligently worked to develop tech based on shoestring budgets, especially if they've been passed over for funding because they're told it's not as advanced as Theranos' smoke and mirrors pitches had people believing the state-of-the-art was. I'm not sure it's quite what it appears at first glance though, so let's take a look at what we know. Here are the key quotes from the WSJ article:

Theranos Inc. told its investors this week that it has secured a $100 million loan from Fortress Investment Group LLC

The loan from Fortress is collateralized by Theranos’s patent portfolio and the deal grants Fortress warrants for 4% of the company’s equity

The loan is “subject to achieving certain product and operational milestones,” 

This leaves the possibilities for what has happened wide open, so assuming that Fortress are savvy and seeing a deal here, I'm going to make some guesses as to what's happening.

• This is a loan, not a traditional investment such as for equity or for convertible debt. In the event of bankruptcy this takes precedence over all other investors such as shareholders - they get paid back before anyone else, so it's safer than equity investing. 
• It's a loan on certain terms and if they don't meet those terms then the company's IP (patents etc) likely become the property of Fortress. (USPTO quick search turns up 115 patents, smaller than I would have expected). They don't just get paid back first, they get the choice assets, likely the only part of the company that has value. What's the value of that IP? Have they evaluated that it could be sold to another biotech firm such as Roche for >$100 million?
• The money is conditional upon reaching milestones - that is, they don't just get handed $100 million to do with as they please, it's going to be metered out in multiple tranches if and only if they hit targets. These targets will be various steps along the way to "receive FDA approval for Zika virus test" and possibly include "not to be sued by investors, customers, or face criminal charges from any federal agencies". Basically, Fortress dole out the kid's allowance very carefully, and will have chosen the trigger points carefully.
• Fortress get warrants on 4% of stock - this means they can choose to buy up to 4% of the company stock at a set price, at a later date. We don't know what that price is, but you can expect it will be at $100 million or most likely much lower. If Theranos pulls a rabbit out of the hat and makes a success of things, becoming a multi-billion dollar company, then Fortress get to own a piece of it at a discount.

So Fortress have arranged a deal where they don't have to put the full amount in up-front, but are still ahead of any other investor, get to own the only valuable part of the company if it goes wrong (the IP), and get discounted stock in the company if it, through some miracle, succeeds. With the right milestones and triggers, this could be a deal where Fortress win no matter what happens, and may actually come out better should Theranos fail. I wonder if Fortress have essentially arranged a deal to make sure that all the good parts are gone by the time everyone else reaches the bankruptcy auction.

Why would Theranos take such a deal? Well, because they have to choice - it's this or bankruptcy.

The outcome

Can the technology succeed? Putting aside who would trust their personal health to a company with Theranos' reputation, possibly, but there's something to look at that is pretty damning as to what is happening internally. From WSJ:

In May, Theranos announced in a press release that it had hired Cass Grandone, a former Abbott Diagnostics executive, to head its product development. Ms. Holmes was quoted in the press release as saying that Mr. Grandone’s leadership would be critical to the company. However, Mr. Grandone resigned last month after just six months on the job, according to a person familiar with his departure.

When someone like this gets brought in, it's to save the product. They get given incentives and bonuses that make it very, very worth their while to see things to completion. If he's leaving after only 6 months to me it says either the technology can't make it to product, or the company is screwed up so badly that even good tech won't succeed (read: clashes with unreasonable CEO). It could be either, or both, but is irrelevant - that Grandone walked is a very bad sign for Theranos. (At least he didn't feel so much pressure he committed suicide.)

So what will happen? Who knows where this bizarre story will end, however I would not put stock in Theranos succeeding - IMO a demoralized company with technology at best no better than the competition, a CEO/founder likely to still believe she can succeed and willing to take any deal to avert bankrupty, with potential for criminal charges and further lawsuits hanging over their heads, will not be a company focused on a world-beating product. 

Perhaps Fortress will walk away from this with all the IP for $10 or $20 million, and leave the rotting carcass for everyone else who put in >$750 million. Quite the deal for Fortress if they can pull it off.

Theranos News

Just a brief update on the ongoing Theranos story. Hopefully in a week or so I'll actually have the time to write something substantial on this again. 

First, Walgreens is suing Theranos for $140 million. Walgreens was the company that had the deal with Theranos to use their Edison blood testing for patients in their stores, and this deal was one of the key reasons Theranos were taken seriously. This is a major blow, and along with the investor lawsuit for near $100 million, and the eight class action lawsuits they have, puts them at good odds of all the money in the bank disappearing in settlements and legal fees. 

Then, Tim Draper, one of the original VCs to invest in Theranos, continues to defend Elizabeth Holmes and starts playing both the victim and sexism cards on her behalf. It's somewhat ridiculous at this stage, and I don't know if it signifies desperation, denial, or delusion.

Finally, another fantastic piece by John Carryrou on the whistleblower on Theranos - the 26 year old grandson of former Secretary of State (and Theranos Board Member) George Schultz. To summarise, he worked at the company and began to question the effectiveness, legality, and safety of what they were doing, reported his concerns up the chain within Theranos, got a beatdown from the COO, left, went to the authorities to inform them, and met with intense intimidation from the Theranos legal team. 

And what was his reward for his good behaviour? $400,000 of legal bills and lost contact with his grandfather. It makes clear that any excuses that the youth of a founder/CEO excuses them from understanding the ethical and legal consequences of their actions are nonsense, and that whether the person in charge is 19, 39, or 99, they are capable of knowing right from wrong. More importantly, though, is that this article should make clear the answer the question "Why are so few people whistleblowers?"