Theranos CEO and founder Elizabeth Holmes listens along with other attendees as Deputy Secretary of Defense Ashton B. Carter delivers remarks at Stanford University in Palo Alto, California, April 17, 2013. (DoD Photo By Glenn Fawcett) (Released)
There’s only so much you can learn from a company’s executives. They are personally vested in the company’s success, and whether or not they want to, they’ll often skew the conversation in a positive direction. What’s worse is that some investors seem ready to buy company stock not based on fundamentals but instead on the star power of the company’s leaders. Brooke Masters reports on the dying art of due diligence in the Financial Times:
It’s been a lousy month for the reputation of professional investing.
The collapse of FTX revealed that everyone from racy hedge funds to staid pension and sovereign wealth funds had been throwing money at a cryptocurrency exchange with weaker financial controls than Enron.
Elizabeth Holmes was sentenced to 11 years in prison for Theranos, a fraudulent blood-testing scheme that deceived Oracle founder Larry Ellison and media mogul Rupert Murdoch.
Shares in tech companies that went public during the 2020-21 Spac frenzy are down sharply, and many crypto firms are teetering. BlockFi declared bankruptcy on Monday despite its claim of being “backed by the best” including SoFi, Tiger Global and Peter Thiel.
Doesn’t anyone do due diligence any more? The boring process of checking that potential investments can live up to their promises has fallen completely by the wayside. Due diligence once meant sending bankers to check that a mining company really had a working gold mine, hiring accountants to scour the books and asking lawyers to identify contracts that could prove troublesome in a bankruptcy.
These days, it is hard to know what due diligence actually means. Ontario Teachers’ Pension Plan, which put $95mn into FTX, insists that its professionals “conduct robust due diligence on all private investments”. Tiger Global, which tossed in $38mn, pays outside consultants including Bain & Co to do the work. Yet both missed what FTX’s new chief has described as a “complete failure of corporate controls”. Sequoia Capital, which handed FTX founder Sam Bankman-Fried $214mn even though he played video games during his pitch to them, has walked a fine line. It issued a rare apology and promised tougher standards in the future, while insisting that it did the proper checks.
Veteran Silicon Valley dealmakers say there has been a gradual erosion of standards, as venture capitalists stopped trying to select and nurture the smartest entrepreneurs and started spraying cash around. The VC model has always assumed most fledgling companies fail but investors were compensated for those losses by getting in early on a few big successes.
However, decades of easy money and a lack of decent yields from safer alternatives mean this approach has spread from early investment rounds involving a few million dollars to gigantic deals involving billions.
As more apparently successful companies stayed private for longer, investors’ fear of missing out on the next Amazon or Google grew. That left them vulnerable to hucksters. Investors started picking companies based on who else was part of the funding round rather than on whether the entrepreneur’s business plan made sense.
Read more here.
