Funding Fantasies: The Fable of the Unicorn

Myths and fables are supposed to be stories from which societies learn in order not to repeat the mistakes enshrined in those tales. Which makes the multi-billion dollar valuation of a radical new blood-testing technology founded by a then 19 year old college dropout with no medical experience so...understandable in the post dotcom era...?

In this case, the old venture capital adage about the investor getting cut and the entrepreneur bleeding is even more apt than usual. JL

The Economist reports:

Theranos evokes a central theme in today’s tech industry: startups which promise to disrupt lucrative businesses and become valued on the basis of fantasies about their potential, rather than present reality. Investors are so keen to get a piece of any sexy-sounding startup that anyone who asks awkward questions risks being cut out in favour of someone more trusting.
“FIRST they think you’re crazy, then they fight you, and then all of a sudden you change the world,” Elizabeth Holmes, the boss of Theranos, said recently. If she is to change the world, first Ms Holmes (pictured) will have to change minds. In the past fortnight she has faced an onslaught of negative press reports saying that her blood-testing firm’s technology is not all it purports to be.
Theranos is one of Silicon Valley’s most prominent “unicorns”, or unlisted startups valued at more than $1 billion. Its aim is to disrupt a market for blood tests that, in America alone, is worth $75 billion a year. A recent injection of $400m from investors gave it an implied value of $9 billion. In early October, just before the bad headlines began, 31-year-old Ms Holmes, who is said to be the world’s youngest female self-made billionaire, was featured on the cover of Inc. magazine in a black turtleneck, with the headline “The Next Steve Jobs”.Opinion can change as quickly as a pinprick. Soon after, the Wall Street Journal ran a report that Theranos has overstated its technology’s reach and reliability. Theranos has attracted great acclaim because it claims to be able to perform a wide variety of tests by drawing a few drops of blood instead of using a full-sized needle to take larger samples; and because of its promises to make it cheaper and easier for consumers to get blood tests without having to go through a doctor. However, the Journal’s article argued that its tests are not reliable, and revealed that it does only a few tests with its own devices, using other firms’ technology for most of them.Ms Holmes said the Journal’s report was “false”, and defended the reliability of Theranos’s tests. But that has not quelled the storm of scepticism. Indeed it gathered force on October 27th, when America’s Food and Drug Administration published reports on its inspection of Theranos. These accused it of distributing an “uncleared medical device”, and registered a few other objections, including that the firm lacked an adequate system for responding to complaints. Separately, GlaxoSmithKline, a giant drugmaker for which Theranos has claimed to have done tests, said that it has not done any business with the startup in the past two years.
The best-case scenario is that Theranos has simply experienced more setbacks than onlookers had expected, and that its technology will eventually catch up with its lofty valuation. Every startup has difficulties, especially in highly regulated industries like health care. Some women working in the tech industry question whether a young man trying to overthrow an established industry would face as much criticism as Ms Holmes has in recent days. But if the allegations prove to be true, at the very least Theranos’s valuation may never again reach the heights seen so far.
In several respects, Theranos is highly unusual in the tech industry. Formed twelve years ago after Ms Holmes dropped out of Stanford University, the firm has not raised capital from the usual suspects in the tech or medical businesses. Only one prominent venture-capital firm, Draper Fisher Jurvetson, has invested, along with Larry Ellison, one of the founders of Oracle, an IT giant. Several of its investors are small-time players with no known expertise in the industry. Its ten-member board boasts George Shultz and Henry Kissinger, two former secretaries of state, but only two people with medical training. The average age of board members is nearly 76.
Yet in other ways Theranos evokes a central theme in today’s tech industry: startups which promise to disrupt lucrative businesses and become valued on the basis of fantasies about their potential, rather than present reality. Investors are so keen to get a piece of any sexy-sounding startup that they lap up entrepreneurs’ hype—and anyone who asks awkward questions risks being cut out of the funding round in favour of someone more trusting.
All this helps to explain the inflation of valuations among unlisted technology companies. Today there are 142 unicorns, more than three times as many as in 2013. Many of them are growing quickly. But in terms of reaching profitability, they are often far behind the stockmarket-listed competitors they are seeking to displace, and thus are burning through cash. Theranos, for example, is not believed to have any significant revenues or profits, yet it is valued about as highly as Quest Diagnostics, a listed laboratory company, which last year achieved $7.4 billion in revenues and nearly $600m in net profits.
Many unicorns have been insulated from scrutiny, because they have no obligation to publish figures or provide progress reports on their technology. Not having to worry about a fluctuating share price frees their founders to think long-term, but also makes it easier for them to brush aside searching questions. However, in time Silicon Valley’s growing herd of fabled creatures will have their encounter with reality. If they do not live up to their promise, their valuations will slump, either at their next funding round or when they finally go public. Many vials of blood may spill.