Theranos Serves as a Cautionary Tale for Biotech Funding

Bay Area biotech Theranos, Inc. took another black eye this week when founder and chief executive officer Elizabeth Holmes and former company president Sunny Balwani were charged with massive fraud by the U.S. government for lying to investors about the capabilities of the company’s blood-testing technology.

The wheels had been coming off the company for the past three years following multiple investigations and reports into the efficacy of the tech. But in the years prior Holmes had a Svengali-type effect on investors in Silicon Valley. For two years Holmes was able to weave tales about her company’s product to raise $700 million from investors – all without really providing evidence of her technology.

In its charges, the Securities and Exchange Commission called Theranos’ actions "years-long fraud" in which they exaggerated or lied about the efficacy of the company’s proprietary technology and the state of its finances. The SEC said the company made false claims about its relationship with the Department of Defense, claiming that its tech was deployed with troops in Afghanistan and its regulatory status with the U.S. Food and Drug Administration. The SEC complaint alleges that Holmes and Balwani made those false and misleading statements during investor presentations and product demonstrations. The company routinely promoted the capabilities of its blood-testing technology that it claimed would revolutionize the healthcare industry.

All of those claims Theranos made were false, according to the SEC complaint.

And there’s a lesson in there for potential investors. Caveat emptor – buyer beware. Writing in Bloomberg columnist Max Nisen noted that there are dangers in biotech funding and Theranos should serve as a warning. But, in the same breath, he noted that the private sector has been furiously investing in the biotech sector. Citing a report from Pitchbook Nisen said in 2017 there was about $9 billion in investments and, if the first three months of 2018 are any indication, this year could be even higher. Nisen said there has already been about $3 billion invested in the sector since January.

Theranos certainly fits the outlier moniker Nisen gave in his article. The company was short on scientific data and long on drawing in politically-connected investors and directors, such as former U.S. Secretary of State George Schultz, current U.S. Secretary of Defense Gen. James Mattis, both of whom served as company directors. Media Mogul Rupert Murdoch was also a prominent investor in the company.

While Theranos is an outlier Nisen said more and more money is being pumped into biotech financing rounds and that can create a worrying effect. Big investments, Nisen said, "inflate valuations and expectations, generate me-too efforts and groupthink, and make for tougher exits."

"If the money flowing into early-stage life-science ventures keeps growing at this rate, there will be consequences. Investing in biotech is hard, even when there isn't massive fraud afoot; treatments and technologies fail constantly, most often in the early stages where private companies focus. Investors are likely to get burned on a larger scale than we've seen previously as they put more money into inherently risky ventures," Nisen said.

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