by The Secret VC
Friday, 17
September 2021
Behind the news
10:41

The Theranos stories they don’t tell you about

Outrageous fraud is common in the world of venture capital
by The Secret VC
Elizabeth Holmes

With so much media focus on Elizabeth Holmes — currently on trial for fraud — you might think that cases like these, of outright fraudsters raising huge money from gullible venture capitalists, are few and far between. But as a VC myself I can tell you: most venture funds have their own Theranos story — they just prefer to keep them quiet.

VCs are always looking for “visionary” founders, but the line between visionary and conman is wafer thin. They often have to make big investment decisions within a few days (the original Google investment was made over a weekend), which means that the scope for fraud is immense. When it does happen, it’s often better to write it off quietly than sue and face embarrassing headlines. After all VCs expect 40% of investments to go to zero.

A few make the news. Erlend Olson, a charismatic cowboy-hat-wearing former NASA scientist, persuaded Kleiner Perkins, Goldman Sachs and others to invest $300M in “Terralliance”, which promised to use “big data” from aeroplanes and satellites to find oil fields. It’s still unclear whether the tech ever worked, but somehow $20M ended up in Olson-related offshore trusts, one of which, I kid you not, was called The Pink Panther.

Mozido was a much talked about mobile payments company, raising hundreds of millions at a $4B valuation from investors including Tiger. But it turned out the founder, Michael Liberty, was siphoning tens of millions into private jets, a dairy farm and a movie produced by his girlfriend. He’s a rare one who got caught — until he was pardoned by Donald J. Trump.

Another common kind of fraud is when founders “fake it until they make it” — showing investors embellished numbers “up and to the right” before attempting to make them up in the next quarter. Some call it “pre-telling the truth”.

Recently, the SEC caught Headspin faking their numbers. Headspin had persuaded top VCs like GV (Google Ventures), Battery & ICONIQ that they were “one of the fastest-scaling software companies ever” — sadly by inventing clients and fudging figures.

Even more commonplace deception in the VC world is “buying” revenue. When companies are valued at up to 20 times their annual revenue, every dollar of revenue adds twenty dollars to the valuation, so it’s tempting to offer kickbacks and other ruses to flatter the numbers (“I’ll pay you to buy my software”). This was the accusation levelled at Mike Lynch of Autonomy, and several healthcare software companies have been caught out (Singulex, Cloudcare, etc.).

Then there are the companies that burn such vast quantities of cash it might as well be fraud. Boo.com, Webvan and eToys burned multi-millions per month in the dot-com boom. Yet they’re dwarfed by more recent cash bonfires like Katerra ($1.5 billion), Magic Leap ($3 billion and counting), Oyo ($4 billion) and, of course, WeWork (which could be as much as $20 billion).

But perhaps most embarrassing of all is the fraud that is perpetuated inside a venture fund. “Shifty” Ifty Ahmed, then a partner at Oak Capital, had a clever tactic: when making a multi-million-dollar investment, he would arrange to “invest” an extra few million in the recipient company; then phone the company, apologise for the embarrassing error and ask them to “return” the difference — to his own account. Apparently he swindled $65M this way before anyone noticed. Oak Capital managed nearly $10 billion.

Fraud follows the money, and there’s never been so much VC money, or so many investors falling over themselves to be faster and more “founder friendly” than each other. To quote a fellow VC, when the tide goes out this time around its going to reveal “a naked orgy of fraud”. But until then, VCs will keep toasting the up-rounds and comforting themselves that, even if they have been duped here and there, at least nobody really noticed.

The Secret VC is a partner at a major VC fund and tweets at @TheSecretVC

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Norman Powers
Norman Powers
10 months ago

Yes, I can attest to this. I did some work for a famous VC firm at one point, won’t name any names. I didn’t see any actual fraud but the grey zone was alive and well. From time to time they’d send me a pitch deck to evaluate, and my response was always don’t invest, due to basic problems in the business plan or claims made. Yet, they always invested in one case because they simply “liked the team” – this is a very common justification for farming out money. I realized after that I just wasn’t cut out for modern day VC work. Actual likelihood of a business succeeding is not especially important – they routinely value other factors higher.
One unfortunate aspect of this is the open secret that you’re much more likely to get money if the company is or appears to be founded by a woman. There has been an explosion in software/tech startups with female CEOs but male “technical co-founders”, which are in reality founded by the men. It’s cynical and corrosive but an inevitable consequence of the times we live in. It’s also the elephant in the room nobody will bring up w.r.t. Holmes. Why did so many people invest so much in her? A large part is surely because they were all desperate to be able to say they were investing in a female startup founder. The social pressure on VCs to do so is immense and there are very few to pick from.

Hubert Knobscratch
Hubert Knobscratch
10 months ago

I’ve worked at an AIM Listed company in the UK, originally launched with VC money.
I think most start-ups with high tech are like this. What they forget is the vested interest from those in a similar field in keeping things as they are.
The tech was good and about 15 years ahead of where other BIG companies are today – but the ability of the replacement directors concerned to deliver it was woeful.
Directors were paid incredible amounts of money for what were in reality – average people.
Today, anything that’s green, high tech etc… gets grant money almost without question, patents fast tracked etc… no problems with funding. An ex work colleague is counting on this stupidity to keep his start up going.
Another ex-work colleague was at a start up doing green stuff. The MD is paying himself £640K p.a. they don’t make any profit, and they employ less than 35 people….
I know someone else placing senior IT exec/professionals in AI start-ups. The VCs have told him “David – consider the sums available for this work infinite….”
With cash so freely available, it’s not a question of “is there fraud”, more of a question of “how much fraud is there?”

Susan Marshall
Susan Marshall
10 months ago

The people who have been harmed here are not the VCs but those whose results are not true. How many have died because of this scandle.
I don’t think the man in the street is very worried about the rich being taken for a ride but they should be worried by the collateral damage to ordinary people.

J Bryant
J Bryant
10 months ago

Interesting article.
Can anyone recommend a good book about how the VC industry really works? I can always search my library catalogue but I’d prefer a recommendation to get started.

Jeffrey Chongsathien
Jeffrey Chongsathien
10 months ago

The root problem is central banks printing currency to keep the economic Ponzi scheme. The widespread fraud is the inevitable result of corrupt society with everyone looking to get a piece of pie.

James Joyce
James Joyce
10 months ago

https://youtu.be/fznLsuY2L30
How can something that doesn’t exist be worth a billion dollars?

CHASING UNICORNS. An excellent movie on this very topic.

Hugh Marcus
Hugh Marcus
10 months ago

Very Interesting, those of us who’ve started small businesses & slogged long hours to try & turn a profit often look on amazed at these companies that seem to come from nowhere, make nothing, (apart from a lot of noise) and yet are ‘valued’ in millions of dollars. I guess the emperor only looks naked if you’re not up close