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Did Theranos mean the end of entrepreneurs fudging the numbers?

Written by Eric Johansson on Tuesday, 21 August 2018. Posted in Commercial law, Legal

There’s a long history of startups exaggerating their numbers to either woo investors or the public. However, the culture of faking it until you make may be at an end after a series of highly publicised company collapses

Did Theranos mean the end of entrepreneurs fudging the numbers?

If you ask some venture capitalists, Theranos’ fall from grace put an end to the era of entrepreneurs fudging their numbers. But no one saw it coming back in 2015. At the time the blood-testing startup was hailed as one of the most impressive Silicon Valley stories ever. At its peak it was valued at over $9bn. The founder and CEO Elizabeth Holmes was repeatedly characterised as the tech industry’s latest wunderkind, an up-and-coming titan in the tradition of Steve Jobs. Then, in October the same year, The Wall Street Journal published a story that totally debunked the illusion.

The report alleged the startup’s so-called revolutionary blood-testing technology was bust, a sham, a fraud. Three years since, Theranos has gone from being a unicorn to essentially seeing its value evaporate, Holmes has been accused by federal prosecutors for defrauding investors for hundreds of millions of dollars and the company’s workforce has dropped from 800 to 20 employees who are reportedly trying to close down the remains of the business. “That gave everybody a big wake-up call,” says Julian Zegelman, co-founder of TMT Blockchain Fund, the investment fund for blockchain startups set up by the VC firm TMT Investments.

The startup scene clearly required a rough awakening. After all, entrepreneurs in Silicon Valley have been no strangers to faking their numbers. “The biggest problem is that, up until very recently, people were so invested into this idea of faking it until you make it,” says Zegelman. He’s not wrong. Another report by The Wall Street Journal looked at 50 tech startups before and after they went public. Among them, 15 were revealed to have considerably lower sales figures in their public files than what they had previously said. Added to that Snapchat’s co-founder Evan Spiegel said the social media platform had 100 million users when it only had 89 million and Facebook has been caught over-estimating its video views and it’s easy to spot a culture of tech firms fudging their numbers. “Everybody understood it and everybody was doing it,” says Zegelman. “Startups were talking about things that didn’t really exist, large corporations were over-exaggerating their numbers [and] venture capitalists were lying about how successful they really were. Everybody was involved in this culture of over-exaggerating, putting only the positive news forward. You know, looking busier or more successful than they really were.”

However, this culture may not be restricted to  San Francisco’s bay area. In April 2018, Cera Care, the UK-based health tech startup, was accused of allegedly posting fake reviews on Trustpilot and of claiming to be partners with organisations that it wasn’t working with. “It’s unsurprising that startups in the UK have been heavily influenced by their US counterparts,” says Lisa Botterill, partner at Shakespeare Martineau, the law firm.

While people may say some startups are lying, Botterill believes the puffed-up numbers were more due to founders’ optimism rather than a desire to mislead anyone. “Entrepreneurs by their nature are usually very positive people,” she says. “They genuinely believe that their business is going to be successful and this is often reflected in their figures and forecasts for the coming years.” Moreover, Botterill argues the numbers may also be due to the founders being new in their roles. “Generally, the larger and more-established the business is, the more realistic financial projections tend to be as they can be based on a track record,” she explains. “Startups don’t have this sort of financial history, meaning that projections are more likely to be based on hope rather than actual experience.”

But no matter whether you’re blaming the wrong numbers on entrepreneurs’ inexperience or a desire to boost valuations, things may be about to change. “I think that more and more entrepreneurs and the people around them were looking at the negative impact [of misleading numbers],” Zegelman says. “The venture capitalists had lost their money, the customers who never got the products they paid for and the engineers that worked for a company for a few years that ended up being just a complete sham, a lot of these people have learned their lesson.” As a result, he believes both founders and the people in the startup community are going to be more thorough with their due diligence in the future. “A lot of folks in Silicon Valley, the younger generations of the entrepreneurs, they are looking at this culture of faking it until you make it and reevaluating it,” Zegelman says.

And there are certainly enough legal reasons for them to do so. “If the numbers that have been presented have been knowingly falsified to entice investors or paint a rosier picture than is factual, this is ultimately self-defeating and depending on the depth of the miscommunication can, in some cases, lead to fraudulent trading,” says Simon Renshaw, insolvency practitioner at AABRS, company rescue experts. If you’re found guilty of fraudulent trading you could face fines as well as lengthy prison sentences depending on the severity. “[So knowing] that you are not being transparent with investors in particular, can come back to bite businesses,” says Renshaw.

Although, things aren’t as clear cut when it comes to distorted forecasts and projections. “If the thought process and estimations used in formulating these can reasonably be justified, then it’s difficult to prove any wilful financial misrepresentation,” Botterill explains. Add to that being known for faking the numbers can cause serious reputational damage to your startup, it’s worth double and triple-checking your numbers before speaking with the press or a VC.

That being said, if you do have an excellent startup with magnificent numbers, then you should be sure to tell the world about it.

About the Author

Eric Johansson

As acting web editor and resident Viking, Johansson ensures EB is filled with engaging and eclectic entrepreneurial stories. While one of our most prolific tech writers, he has sharpened his editorial teeth by writing about entertainment and fitness. Follow him on Twitter at @EricJohanssonLJ to catch up with his stream of consciousness.

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