5 Ways You Can Avoid Fraudulent Companies: Learn a Lesson from Theranos

By Chika

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Last Updated: January 15, 2022

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The mushrooming of corporate fraud cases is a stark reminder that investors should not sit back and believe that the regulators and authorities will always protect them against unscrupulous companies. 

Theranos founder, Elizabeth Holmes was found guilty on four counts of fraud brought against her. Holmes raised $945 million from high-profile investors about a decade ago which included the family of former Education Secretary Betsy DeVos, Rupert Murdoch, and the Walton family of Walmart fame.

To those who had invested in her company, the pain that accompanies a financial loss may be too severe to bear. Some may never be able to recover from the shock of loss, let alone recoup their investments. 

The sad reality is Theranos isn’t the only bad apple out there; it is yet another entry in the catalog of corporate fraud spanning from Enron and WorldCom to Bernie Madoff and Nikola

The present-day investor is now faced with an uphill task of vetting companies and investment opportunities. As a result, the Theranos case provides an ample case study on how investors can avoid investing in fraudulent companies.

 

5 tips investors can use to spot and avoid shady companies.

1. Be wary of innovative companies that promise change

Theranos was a Silicon Valley fairy tale. A young, charismatic CEO proposes a revolutionary, industry-changing idea that will heap rewards on all involved.

These seductive, too-good-to-be-true stories do become real in Silicon Valley. Not every company can be Facebook, Google, or Apple.

Companies which claim to be disruptive and innovative are sometimes fraught with challenges that may be hidden from the public eye. Because these companies are starting up, there may still be operational challenges that may make them uninvestable at the moment.

However, in their quest to make money, they solicit funds from unsuspecting investors. 

An exemplification of this is the proliferation of Special Purpose Acquisition Companies (SPACs) into the stock market in 2020 and 2021. Both years saw a record entrance of SPAC companies, many of which were unprofitable or barely operational. 

 

2. Dig into the profile of board members and management

The character of the company's board members and management can offer an insight into the value of the company and its culture.

While you should pursue their career history, you should also try to get an inkling of their personal life as well.

Right from the early days of Theranos, Holmes flew around in a private jet, while staying at a mansion on a $135m Silicon Valley estate. She also had a personal publicist whom she reportedly paid $25,000 monthly. The display of ostentatious lifestyle by board members of senior executives in a company is usually a red flag investors can watch out for. 

 

3. Focus on proven results, not speculation

A lot of companies have seen their valuations bloated on empty promises and no results. In the quest to find the next Apple, Amazon, or Tesla, many investors have turned to speculators, betting on companies that have no products.

Some of these companies are promoted by the media and Wall Street investors to generate huge following and interest. 

The case of Rivian, (Not saying it is a fraud) aptly fits this bill. On its public debut, the valuation of Rivian reached over $90bn, far above legacy automakers such as Toyota, Ford, GM Motors, or Honda.

However, this company was yet to deliver a single truck let alone make a profit. Other examples in this category include DoorDash, Palantir, and Snowflake: all unprofitable when they went public.

 

4. Sentiments and money don't mix

One of the reasons postulated for the Theranos fraud was that sentiments clouded the judgment of investors.

Elizabeth Holmes, being a young intelligent woman blazing trails was well received by many people. 

A woman breaking the proverbial glass ceiling in a male-dominated business sat well with people looking for narrative change. This made her amiable to investors and the financial media with some comparing her to Steve Jobs, based on the promise of her product. 

However, all this did not turn out to be true. This is similar to the Bernie Madoff saga. Investors got carried away by the personality, position, and charisma of the individual, rather than the underlying fundamentals. 

 

5. Treat every company as a fraud, even if it is promoted by the media

What do Elizabeth Holmes, Bernie Madoff, and Trevor Milton have in common?

They were all celebrated by the media, yet turned out to be major frauds. This implies that you should not believe everything you watch on the media. The onus is on you to do your due diligence and investigate the company deeply before putting in your fund.

One way to go about this is by reading a short-seller report (if any) on the company. This may give you a microscopic view of the company's operations and business model. 

Photo by Dan Dimmock on Unsplash

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