Investor due diligence: the Theranos case

The Theranos case is a textbook example of what happens when due diligence is insufficient or improperly conducted. Investors, captivated by Elizabeth Holmes' charisma and the allure of her promises to revolutionize healthcare, poured hundreds of millions of dollars into the company. The due diligence process, or the lack thereof, overlooked several red flags that later became pivotal in the company's downfall.

How Did Investors Conduct Their Due Diligence on Theranos?

1. Overreliance on Founder's Charisma and Vision: Investors were largely influenced by Elizabeth Holmes' compelling narrative and her vision of disrupting the healthcare industry. This often led to an underestimation of the technical challenges involved and an overreliance on her assurances rather than seeking independent verifications.

2. Lack of Expert Opinion: Many investors did not seek insights from independent medical or scientific experts who could have critically evaluated Theranos' technology claims. Those who did raise concerns were often dismissed or overshadowed by the positive reviews from notable board members and the company's aggressive patent filing strategy, which was perceived as indicative of technological innovation.

3. Secrecy and NDA Use: Theranos used non-disclosure agreements (NDAs) extensively, citing the need to protect its proprietary technology. This legal barrier prevented many investors from conducting a thorough technical review and dissuaded external experts from providing unbiased assessments.

4. Board Composition: The Theranos board was composed of prominent individuals from politics and business, but it notably lacked members with deep expertise in biotechnology or medical devices. This skewed board composition may have contributed to a lack of critical oversight on the technological claims.

Areas for Improvement in Due Diligence

The Theranos debacle highlights several areas where due diligence practices can be improved:

1. Technical Verification: Investors should insist on independent, third-party verification of a startup's technology, especially for claims that promise to revolutionize an industry. This might involve consulting with experts in the relevant fields who can critically assess the feasibility and functionality of the technology.

2. Transparency and Openness: A red flag for investors should be a company's unwillingness to disclose information or allow for independent testing of its products. A balance must be struck between protecting intellectual property and providing enough transparency to validate claims.

3. Comprehensive Risk Assessment: Due diligence should include a comprehensive risk assessment that considers regulatory, market, and technological challenges. In Theranos' case, the potential regulatory hurdles of getting a medical device approved were underestimated.

4. Diverse Expertise on Boards: Ensure that the company's board or advisory panel includes individuals with relevant industry expertise who can provide critical oversight and guidance. A diverse board can challenge management's assumptions and decisions more effectively.

5. Financial and Legal Checks: Beyond the technology and team, thorough financial audits and legal checks are essential to uncover any potential misrepresentations or issues that could impact the company's long-term viability.

6. Ethical Considerations: Due diligence should also assess the ethical implications of the company's business practices and technology. This includes considering the potential impact on end-users and the broader societal implications.

In essence, the Theranos case serves as a stark reminder of the importance of rigorous and comprehensive due diligence. By learning from these oversights, investors can better protect themselves against similar pitfalls in the future, ensuring that their investments are both sound and ethical.