What Indian startups must learn from fallen unicorn Theranos

Holmes, once hailed as the “next Steve Jobs”, had dropped out of Stanford to start Theranos in 2003 when she was just 19. Her revolutionary disease-diagnosing ‘Edison Test’ promised to detect cancer and diabetes without the use of needles, and with just a tiny amount of the patient’s blood at a fraction of the usual cost and time taken by traditional technology.By 2010, having received several rounds of funding, Theranos had achieved the status of a unicorn, valued above $1 billion.You might also like Will CNG upstage diesel as fuel of choice?Aryan Khan & a devil-may-care bet on premium liquor Why Godrej Properties may take time to recover What the sharpest growth in risky AIFs means How much of its unicorn status was the result of investor gullibility and what role did a marquee board play in the making of this unicorn?Most investors in Theranos were probably driven by loss aversion and a fear of missing out on one of the ‘hot rising stars’ among Silicon Valley startups, especiallyl y in the context of the interest shown by and investment pouring in from high-profile investors. The latter included media mogul Rupert Murdoch, who had led a Series A round of funding as early as 2005, along with others such as Oracle founder Larry Ellison and the US pharmacy and retail chain Walgreens. Such investments from reputedly hard-nosed businessmen and executives can be explained by drawing on the concept of a ‘representative heuristic’, a mental shortcut which involves estimating the likelihood of an event by comparing it to an existing prototype that already exists in the mind. The prototype then is considered the most relevant or representative of a particular event or an object. Holmes’ status as a college dropout from the Ivy League Stanford, after having spent two semesters doing chemical engineering, probably led investors to overestimate the probability of Holmes-backed Theranos becoming the ‘next big unicorn’. Such a representative heuristic may have been responsible for a ‘base rate bias’, wherein investors ignored the fact that the Theranos technology had never been submitted for peer review in medical journals. ‘Gullible’ investors seem to have paid scant attention to a statistical base rate, namely the success rate of the new technique, which for some medicines can be as low as 1%. Instead, they display the typical human tendency of looking for patterns and at causal base rates. In such a world, successful startups would be ’caused’ by bright young restless minds dropping out of colleges to create unicorns, as in this case. Added to this heuristic may be an overconfidence bias, which caused fund managers and investors to throw caution to the wind, due to false and misleading assessments of their own skills, intellect or talent. What else can explain the fact that the company not only became a unicorn, but had reached a peak value of $10 billion by 2015, despite Holmes’ clear inability to explain Theranos’ technology? In fact, even when she explained this supposed innovation as “chemistry is performed so that a chemical reaction occurs and generates a signal from the chemical interaction with the sample, which is translated into a result, which is then reviewed by certified laboratory personnel”, it failed to raise enough suspicion among investors.The Theranos board comprised several well-known names, such as former US secretaries of state George Shultz and Henry Kissinger, former US defense secretary William Perry, and a former chief executive officer of Wells Fargo & Co. Holmes’ need to put together such a board is not surprising, Richard Kovacevich, besides former US Navy admirals and other senior defense personnel, given that the company planned to sell its blood-testing devices to the military. people fail in their vigilance, refuse to speak up when confronted with damning evidence of failure, and continue to back a nefarious company with questionable techno log? One of its whistleblowers, Tyler Shultz, was a Theranos board member, George Shultz’s grandson. Tyler had been convinced of wrongdoings in the company within a few months of starting work at Theranos. However, when he raised questions about shoddy quality controls and doctored research at Theranos, he faced resistance from within his own family. His grandfather chose to ally himself with Holmes and Balwani, leading to a family rift. Similarly, one of the other investors, Tim Draper, continued to be an outspoken defender of Theranos until 2018. Individual investors and boards comprising well-recognized and reputed individuals, such as at Theranos, may fail to prevent such frauds on account of a range. of biases, heuristics and social pressures affecting their judgement. The cognitive bias of hyperbolic discounting, for example, leads to the threat of reputational loss being seen as a mere likelihood in the distance, in contrast with the real possibilities of instant gratification or rewards through re-election to the board, higher valuation gains, contract renewals, etc. In the wider field of healthcare, the famous Tylenol case demonstrates how the human preference for immediate gratification, along with an insufficient regard for potential negative future consequences, can lead to disastrous consequences. Board members, investors, auditors and other stakeholders associated with the governance of startups, and indeed of large companies as well, must understand the limitations of the traditional approach to corporate governance, based merely on resolving the so-called principal-agent problem. Corporate India will need to invest on understanding behavioural corporate governance, since infractions of the Theranos sort, far from being an exception, may turn out to be the rule even as we toast ‘Startup India’. Tulsi Jayakumar is professor, economics, and executive director, Center for Family Business & Entrepreneurship at Bhavan’s SPJIMR These are the author’s personal views. Elsewhere in Mint In Opinion, Raghu Raman argues for corporate rituals and spaces for free expression of mind. Siddharth Pai says NFTs look headed the crypto way. Long Story narrates how Foxconn fixed its faltering India operations. 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