First Stage Investor

Don’t Fall for Another Theranos

Don’t Fall for Another Theranos
By Andy Gordon
Date February 4, 2019

On the heels of sending out my most recent recommendation, Phoenix PharmaLabs (PPL), I came across an ominous warning…

It’s a Stanford University study on the dangers of investing in healthcare startups.

It speaks to issues I’ve been talking about for years: the importance of due diligence in the startup healthcare sector and the danger of Theranos-like scandals rearing their ugly heads… again.

Theranos is one of the highest-profile busts (or scams – depending on your point of view) we’ve seen in recent years. Theranos raised a massive $1.4 billion from some of the most successful venture capital (VC) firms in the business after claiming it had developed a technology that required just a drop of blood to run tests.

But after a spate of customer complaints, Theranos became the target of several government investigations. Officials found that its claims were grossly exaggerated. Last September, it ceased operations.

So how did the VC community miss the warning signs? Where was its due diligence?

The answer is pretty straightforward.

Theranos lied its way to getting more than a billion dollars in investments from investors who failed to do their homework.

VC investors were too cavalier, too swept up in FOMO (fear of missing out) and too mesmerized by the miracles of new technology to sniff out a dishonest company.

My theory (which doesn’t excuse what happened) is that every VC investor who opened their checkbook assumed the previous investor did their due diligence.

That’s sloppy thinking and lazy vetting.

Lesson Not Learned

It was a hard lesson. Yet, according to the study, it didn’t take.

One of the study’s authors recalled, “Many years ago, I was the first person to say that Theranos had a problem… that [it] did not have any peer-reviewed evidence to show.”

It seems that the problem still persists. The study found that more than half of the healthcare startups worth more than $1 billion have published no highly cited papers at all. For companies that were acquired or are publicly traded, that number is around 40%.

The authors warned that portfolios containing life sciences startups suffer from a systemic lack of transparency, inviting the possibility of more multibillion-dollar scandals like Theranos.

When I was vetting PPL (which wasn’t included in the study), my conversations with PPL CEO Bill Crossman also indicated that things haven’t changed much.

He told me it wasn’t the professional investors who asked the most probing questions. It was the professional medical people, namely doctors. They wanted the names of the medical studies where Bill was getting his testing data from. (For my own due diligence, I asked him to send me the names of those studies as well.)

I don’t think these “highly cited” studies are a magic bullet. But it’s better to take them into account (even on a skeptical basis) than to completely ignore them.

This experience is also why I believe that if Theranos had tried private equity crowdfunding, it might never have been funded. With hundreds, if not thousands, of sets of eyes looking at Theranos’ research and business plan, the flaws – and outright lying – would have been exposed by some skeptics.

And I can only hope that this Stanford study’s warning – for investors not to overlook systemic problems created by the lack of transparency among healthcare startups – is heeded.

Both startups and investors need to do better.

Invest early and well,

Andy Gordon
Co-Founder, First Stage Investor

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