Published in the San Diego Union-Tribune, January 17, 2022
by Neil Senturia
At this point, slightly more words have been written about Elizabeth Holmes than have been written about Elvis Presley. But I can’t resist playing “Blue Suede Shoes” one more time. Multiple writers have pointed out the difference between hopeful, optimistic sentences and straight out lying. Failing is OK. Fraud is not.
I recently talked to a small group of wealthy men and women who for some unknown reason felt the need to learn more about startup investing. Their interest and questions confirm my suspicion that there is just too damn much money sloshing around in the pursuit of unicorns, often settling for squirrels or dead pigeons.
The title of the talk was “When Was the Last Time You Were Fleeced?” One of the key defenses for Ms. Holmes was the theme that her investors should have done better due diligence. This is a nuanced argument at best. An investor should not need to have a forensic degree from the FBI to determine if the fingerprints on the gun belong to the CEO. What the hell is the CEO doing with a gun in the first place?
But let me be gracious and agree that doing due diligence is an important part of investing. And now let’s tell each other the truth. It is very hard to dig deep, to really understand the financials, the addressable market, the cost of goods, the monthly burn needed just to keep the doors open. I love magic, and to my way of thinking, misdirection and illusion are often the Scylla and Charybdis of the basic investor pitch deck.
One of the mantras for the startup investor is “to bet on the CEO, the founder, the team.” In other words, even if you don’t know anything about quantum mechanics or mRNA, you can feel a little better if the CEO has led two other successful companies and is a domain expert in the field.
But here is what you can’t do easily, without a psychiatric profile. You can’t dig into how she will manage, how she will lead, how she will build a company. It is very difficult to really look under the fingernails and see if the CEO is going to tell you the truth. You can’t stress test the founder, in part because deals are so hot right now, that if you probe too deeply, you get tossed to the sideline.
My mother gave me the following advice. Before you marry a woman, son, take her camping on a rainy night and cut a hole in the roof of the tent and see what she has to say to you in the morning. Words of wisdom from a Jewish mother.
I was recently introduced to a young entrepreneur. Had never run a company before, but he blithely told me he was going to raise $60 million in the series A round and ultimately would need $300 million to bring the drug to market. Money raised to date, unimpressive. The attorney for the company was his father. Together they own 95 percent of the company. Red flags waving in the breeze.
Most VC due diligence centers around financials, patents, customers, etc. But trying to analyze future behavior (especially when it is raining) is the more valuable and the more difficult diligence.
Confession is good for the soul. I was a very early investor in a company. I met the co-founders. One was strange and I knew he was going to be a problem. I wrote a check anyway, and unfortunately, I was right, he continues to be a significant problem.
And here is the hubris on my part. I assumed that I could “fix” it, that I could prevail on him by sheer dint of charisma, charm and logic. And I was dead wrong. I did the due diligence and then ignored my own medicine, closed my eyes and looked the other way. Do you think the famous names of Silicon Valley did the same thing with Theranos? Do you think FOMO (fear of missing out) clouded their analysis? Do you think they assumed they could “influence” Ms. Holmes to listen to their concerns?
Or did the investors get blinded by the golden hair, the Stanford pedigree, and the Steve Jobs turtleneck?
Rule No. 697: “In the ballroom with the candlestick.”
— Colonel Mustard