How did Theranos have any value at all?

Question

Theranos, an infamous case of a tech startup gone bad, was valued at over 9 billion dollars for audacious claims of revolutionizing the blood-testing industry. The trouble is, it had done so with absolutely no evidence that it could accomplish what it claimed. How is this possible?

One may counter that many startups offer ridiculous, unsubstantiated claims - but none to this extent of success and (I would argue) none with such an easily-substantiated promise. I'm sure people scoffed at the valuation of Facebook or Uber, but these services are investing in social changes that are, by their very nature, nebulous. Theranos made a very simple claim and failed to deliver for over two years, accruing enormous amounts of funding in the mean time. I have never seen a story focus on this aspect, merely how "shocking" it was that they were defrauding investors. Not to victim-blame, but to me the bigger story is how anyone continued to give money to a company that couldn't demonstrate that it could do its most basic function.

As a casual investor, it's shocking to me that companies can achieve this level of financial success without a functioning service. This would be like someone discovering that McDonald's didn't actually have any physical locations at all, and had never served a single patty. It's absolutely mad. Was there something unique about the Theranos case that made it immune to even the most passive of investigation?

To be more specific, Theranos claimed they could perform a myriad of tests with only a single drop of blood. They used competitor's equipment/existing technology to perform their tests instead (which cannot do it with only a single drop of blood) - meaning they could not, even while obfuscating the process, achieve their stated goal of "one drop of blood => many common blood tests".

Answer 1

Something to add, as some have already briefly mentioned, Theranos was able to perform blood tests with some of their stated features (though not reliably enough). The biggest issue was their inability to perform the revolutionary aspects of the product like 1. take multiple kinds of blood tests 2. from a small amount of blood 3. taken from a patient's finger (finger prick blood test).

I think the biggest issue with Theranos as John Carreyrou notes in his book Bad Blood is that Elizabeth Holmes approached a biotech startup the way that many do with software-based tech startups. Software-based tech startups can pitch their idea of a product, raise VC to build that product, and then build it pretty easily. Most investors can accept this sequence of events in good faith, but primarily because most software products/solutions can be created in time/with the right developers. It is much harder to tell how likely something can be created at all in the biotech world. And if a "start-up idea" is possible, how long will it take to create? The life sciences are full of whole humans who are "edge cases" so to speak.

Also as Carreyrou notes, biotechnology more often than not deals with human life, and thus requires much more caution and due diligence. The worst-case scenario for many software solution companies are bad products. Theranos risked human lives for a hypothesized idea, which Carreyrou notes she thought up as a child. She dropped out of Stanford within her first year of school -- missing a foundational education in biology/biomedicine. She went on to start Theranos, and began telling investors that Theranos had created a product they had not created so that she could raise more funding.

Answer 2

What I took away from reading Bad Blood was that if the technology ended up working, the value potential was HUGE. For the most part, investors and joint ventures who got burned were suffering from FOMO. For example Walgreens rushed into a partnership with Theranos because they didn't want their competitors to beat them to this "revolutionary" new technology that had the potential to change the industry.

Additionally, Betty Holms also connections in the VC community through family, and was able to leverage those connections to fill her board with seemingly reputable people.

Answer 3

There's actually quite a lot to unpack in your last paragraph.

As a consumer investor, it's shocking to me

I don't know what a consumer investor is? Did you buy a theranos product? Did you invest in theranos?

that companies can achieve this level of financial success

I'm not sure you can call what happened at theranos a financial success. A lot of money was funneled from investors to employees. Buy anyone holding any sort of note or equity would not call this outcome a success; not by a long shot.

without a functioning service.

The service was more or less ok. Successful blood tests were just completed using competitor testing equipment because the theranos equipment wasn't reliable enough.

This would be like someone discovering that McDonald's didn't actually have any physical locations at all, and had never served a single patty.

I don't think this comparison is valid. It would be like if fast food was a highly regulated industry and McDonalds sought to change the way meat was converted from cow to burger but didn't fully appreciate the regulatory hurdles it faced; or that the patty had to be 90% beef 99.9% of the time, not 85% beef 95% of the time and this is non-negotiable to the industry and regulators so McDonald's ultimately just bought Burger King patties with the hopes it could convert to the in-house process in the future.

It's absolutely mad.

Sure, sometimes the VC/PEs get a little too optimistic. For probably most investors in theranos this was simply one position in a portfolio. A large and risky position, sure, but still one of many.

Was there something unique about the Theranos case that made it immune to even the most passive of investigation?

I'd bet that theranos had tons of due diligence performed by many investors but optimism trumped the cynical view.

Answer 4

By the definition of financial success you offer in the comments, namely "receiving enormous amounts of funding/investor attention", Charles Ponzi was also financial success, and he undoubtably had a business plan more dubious than that of Theranos. The other answers cover the plan it had to make money but there is also a psychological component of why people were buying into it.

As Wikipedia puts it "Even though Ponzi's company was bringing in fantastic sums of money each day, the simplest financial analysis would have shown that the operation was running at a large loss". Basically his idea was to arbitrage international postage stamp price differences, and early on in his scheme more than one member of the media media realized that it couldn't possibly work - for instance, it would require something like 6000 times more stamps to be in existence than currently were, and the overhead of the operation would wipe out any profits achieved. Yet, despite this, Ponzi still managed to not only pay out multiple runs of mass claims to redeem their "investment", but to subsequently convince some of these same peoples to keep or reinvest their money with him and to attract even more "investors".

Likewise, if you do a web search with the terms "theranos elizabeth holmes steve jobs" you will find stories about how she admired Steve Jobs and tried to emulate him, even down to the "reality distortion field". Disconnected from a product that actually could technically succeed, and you wind up in a situation where a person with the vehicle of their company can literally hype up and sell something worthless and by the definition, at least for a time, achieve "financial success".

Answer 5

Short answer in coding terms: Garbage-in Garbage-out. Valuation is a calculation based on estimates.

Medical Laboratory Tests are highly profitable and revenues are measured in Billions. (Mayo Medial Laboratories does more Top line revenue than Mayo Hospitals in Rochester and Jacksonville combined). The Theranos product, had it worked, could have moved testing from labs to pharmacies and medium size medical practices. It could be argued that they were on their way to disrupting / displacing established players such as Quest Diagnostics.