Theranos Debacle Triggers an Avalanche of Lawsuits by Investors Who Should Have Known Better

Very wealthy people dazzled by founder Elizabeth Holmes stampeded to invest huge sums. Now they want their money back.

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By Steve Tobak • Dec 12, 2016 Originally published Dec 12, 2016

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Elizabeth Holmes, founder and CEO of Theranos.

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As the facts in the Theranos mess come to light in one damning report after another, and the lawsuits begin to pile up, you've got to wonder how so many investors -- who should have known better -- got mixed up in what may very well turn out to be a wipeout of nearly $1 billion in capital. It's a fair question to ask.

As it turns out, most of the funds were raised from private individuals and companies that, in my opinion, had no business backing a high-risk biotech startup. And if they hadn't, none of this would have happened.

Bay Area hedge fund Partner Fund Management (PFM) was the first major investor to sue the ill-fated blood testing unicorn and founder Elizabeth Holmes for fraud. Like most hedge funds, PFM typically invests in public companies, where the risk is far lower. Why it wrote Theranos a $96 million check at a $9 billion valuation is a mystery to me.

Related: What Entrepreneurs Can Learn From From Theranos's Fall From Grace

Walgreens, which hosted Theranos wellness centers in some of its pharmacies and invested $140 million, followed with its own lawsuit soon after PFM. That deal was negotiated directly between Holmes and Walgreens' former CEO, CFO and pharmacy president, all of whom were forced out prior to the 2014 merger with Alliance Boots. Coincidence? I don't believe in coincidences.

On Monday, Robertson Stephens co-founder Robert Colman filed the first investor suit seeking class-action status. The retired investment banking pioneer invested a few hundred thousand dollars through a boutique venture capital firm. The law firm handling the suit says there might be several hundred plaintiffs, according to the Wall Street Journal.

Theranos may look like any other high-tech venture that simply didn't pay off, but looks can be deceiving. Early funding came from noted VC firm Draper, Fisher & Jurvetson, but it turns out that Holmes went to school with co-founder Tim Draper's daughter. They were neighbors.

If any other VC firm lining Silicon Valley's famed Sand Hill Road was sought by Theranos, they didn't bite. Nor did any venture capitalists that specialize in life sciences. According to Google Ventures partner Bill Maris, Holmes' claims of revolutionary technology that remained shrouded in secrecy and had never been vetted raised "red flags." I'm sure he wasn't alone in that assessment.

Related: 5 Insights Into Venture Capital Entrepreneurs Need to Know Now

That's probably why Theranos raised money through such unconventional channels -- hedge funds, high-net-worth individuals, private companies and deals with Safeway and Walgreens, both of which fell apart. The one thing they all had in common is that none were allowed to vet the technology. Rather, they were all shown PowerPoint pitches, spreadsheets and controlled demos.

Make no mistake, that's not how it usually works in the Valley. The Theranos phenomenon was born of a gold rush mentality by cross-over investors champing at the bit to get in on the latest tech unicorn before the private equity bubble deflated. The whole situation was dysfunctional. It never should have happened.

But here's the thing. The Theranos situation is no different than when your wantrepreneur neighbor, shyster accountant or overzealous investment advisor comes to you with a sure thing that can't lose. Take it from me: It isn't, it can, and it usually does.

Maybe the scale is different, but everything's relative. Your four or five figure check is worth the same to you as the ones with all the zeros written to Theranos. In either case, when it comes to venture investing, there are lessons to be learned.

No matter how you spin it, it's gambling, plain and simple. Remember the golden rule: Don't bet more than you can afford to lose. Most startups go under. So before you pull the trigger, make believe you've lost it all, and see how it makes you feel. If it makes you feel even a little bit queasy, don't do it.

Better still, leave it to the pros. The venture capital model works because venture capitalists don't make payments from their own bank accounts. They're capitalized by limited partners, do dozens of deals, focus on limited areas of expertise and do serious due diligence.

After they lose their shirts, you always hear people say they should have listened to their better judgement. Trust your instincts, but do it before you write the check. If it sounds too good to be true, sends up red flags or is not in your area of expertise, don't do it.

Related: The Benefits of Buying a 'Boring' Business Instead of Seeking the Next Big Thing

Lastly, consider boxer Mike Tyson, who burned through $400 million on his way to the poor house. The reason why such a high percentage of professional athletes, musicians and actors end up in bankruptcy court is that they make dumb investments they have no business making. That, and they spend money like it's free.

Take it from Curt Schilling, Scottie Pippin, Kim Basinger, Willie Nelson, those who backed Theranos and me: If you're not a venture capitalist, don't write checks like one.

Steve Tobak

Author of Real Leaders Don't Follow

Steve Tobak is a management consultant, columnist, former senior executive, and author of Real Leaders Don’t Follow: Being Extraordinary in the Age of the Entrepreneur (Entrepreneur Press, October 2015). Tobak runs Silicon Valley-based Invisor Consulting and blogs at stevetobak.com, where you can contact him and learn more.

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