December 2020


Sean Dempsey

“Nobody knows anything” - William Goldman, Hollywood screenwriter

The book Bad Blood details the true story of the staggering rise and devastating fall of erstwhile blood-testing company Theranos. While we at Merus were already quite familiar with the saga of Theranos and its magnetic founder Elizabeth Holmes, we still found ourselves enthralled in the drama and shocked by the behavior of the individuals chronicled in the book.

By now, you’re likely aware that the story of Theranos is, at its core, a story of deception. The company simply never built the blood-testing device it claimed to have developed. As envisioned, this portable device would be capable of running hundreds of tests, using only a few drops of blood from a prick of the finger. But the company’s prototype devices malfunctioned repeatedly, broke down often, and produced highly inaccurate results, when they produced results at all. These facts were hidden for years from investors, partners, media, and most employees.

At the same time, the public profile of Holmes and the company continued to rise. As wealthy families like the Waltons and Murdochs invested hundreds of millions and 4-Star Generals and former Secretaries of State joined the Board, Holmes was showered in media attention and entrepreneurial awards. Companies like Walgreens and Safeway rushed to build exclusive partnerships with the company. Everyone wanted to believe. The narrative of Theranos and Elizabeth Holmes was just too compelling--a Stanford dropout with unbounded ambition and a world-changing vision, a breakthrough invention that would save lives, the first self-made female billionaire. This was a Silicon Valley legend in the making. Until the truth surfaced and it all fell spectacularly apart.

While we’ll leave the fascinating details of the story to the book, as investors in Silicon Valley, we think it’s useful to review the lessons one might learn from the fall of Theranos.

The relationship between independence of thought and due diligence

Maintaining independence of thought is critical for investment success in any asset class. And the basis for forming a particular, and potentially uniquely valuable, point of view begins with performing due diligence. This is not a complicated process. It should include activities like seeing a working demo of the product and spending time with all company executives, not just the CEO. An investor should talk with customers and introduce new ones. Pay attention to the little details that might signal something deeper.

In reading the book, one realizes how few of those individuals surrounding the company did their homework. Interestingly, the few people that actually did their due diligence like the consultant that Walgreens tasked with vetting the opportunity, did raise alarm bells. But this consultant was willfully ignored by the Walgreens CEO who was desperate to ink a deal with Theranos before competitor CVS did so.

But what leads to investors failing to do their homework? Fear of missing out is certainly a factor. Savvy founders will create a sense of urgency in a deal, causing investors to short circuit due diligence in an effort to participate in the round. Over-fitting of a familiar fact pattern is also a contributor. In the case of Theranos, Holmes appropriated a Steve Jobs narrative. A commanding personality, change-the-world attitude, sexy hardware designs and even a standard wardrobe of black turtlenecks. It was a compelling story that caused stakeholders to believe they were in the presence of greatness. Lastly, it’s of course much easier to rely on the opinions of others, particularly if they are well-regarded, rather than doing the heavy lifting of due diligence yourself. Which leads to the next lesson.

“Nobody knows anything”

This might be our favorite quote here at Merus, and one we refer to year after year. Hollywood screenwriter William Goldman (Butch Cassidy and the Sundance Kid, All the President’s Men, The Princess Bride), said this in reference to motion pictures. His perspective was that no one in Hollywood could predict with certainty which movie would be a hit. As a result, one should not follow the flavor of the week or sacrifice a vision because someone else pretends to know better. We find this correlates very well to investing and company building. Social “proof” is not a substitute for due diligence. It’s not helpful to an investor to put anyone on a pedestal or to allow narratives to inform a point of view.

At Merus, we firmly believe that forming an independent point of view can only occur with an understanding that “nobody knows anything.” In fact, you might say it’s in our blood.