Whitepaper: Five Steps to Avoid Startup Fraud
Welcome to Molecular Ideas, and thank you for sharing your time with us. Today, we examine how innovative life science companies walk the line between aspiring visions and defrauding patients, practitioners, and investors. We also provide easy and effective exercises to help you guide your own company's development.
Our Discussion At A Glance
Following the results of the trial of former Theranos CEO, Elizabeth Holmes, it is important to understand how to balance aspirational visions for a company with the realities of advisor insights, clinical data, and the law.
The difference between startups that succeed and the startups that implode are defined by the team's paradigms around vision, problem-solving, and external transparency.
Creating accountability structures that bridge internal decision-makers with external validators and influencers can help hedge against poor decisions.
Read on for specific tools, tips, and tricks for aligning your team around a narrative that reflects what is both aspirational for the future and feasible for today.
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The Potential of Potential
As life science innovators, we all want to live on the cutting-edge. Our technologies have the potential to change the lives of patients, practitioners, and investors.
The most important word in that last sentence? Potential.
Innovations in diagnostics provide unparalleled access to key insights that can be used to guide or change the course of treatment. New therapies can drastically improve outcomes while minimizing effects on quality-of-life. The ability of these products and services to create financial savings is immensely valuable. That's why startups move technology from the realm of basic research (typically rooted in academia) to the market - usually with the understanding that more work needs to be done.
However, there are no facts about the future. That's why innovation needs faith and investment to succeed. Before there can be investment in the form of human capital or financial dollars, founders must have faith that their idea is valid, valuable, and can change the market. This faith is what underlies aspirational vision statements and bold investor presentations.
It also represents the first step on a long tightrope, where investors balance the thrill of a technology's potential to do good with the chance of a long, hard fall to Earth.
Trust, but Verify
You can't stop fraud with the placebo effect.
Last week, the founder of Theranos, Elizabeth Holmes, was convicted in federal court for three counts of wire fraud and one count of conspiracy to commit fraud. As we know, fraud begins by purposefully misrepresenting the nature of a product or service. This can lead to suffering through damage inflicted directly, or indirectly through actions not taken as a result of misinformation.
After raising nearly $1.4bn over the last decade-and-a-half, the unicorn of Silicon Valley spectacularly imploded. In the rubble, investigative reporters like John Carreyrou, lawyers, and investors found an aspirational vision backed by a poorly validated and inaccurately marketed technology. As a result, they failed to hit key milestones, defaulted on their debt, and the lawsuits began.
While this may appear to be justice served for the patients and investors who were misinformed about Theranos' technology, I'm not a lawyer. I am not sure whether four fraud convictions out of eleven counts speaks to a clear and decisive victory (legal, moral, or otherwise).
What I am sure of is that in our field, patients put their lives in our hands. That makes one failure to properly verify the technology one instance too many. Unfortunately, Theranos is not an isolated incident. uBiome (the "23&Me of Poop" gut microbiology testing company) reportedly defrauded investors and insurance companies through inflated sales numbers through questionable billing practices and lackluster supporting science. The raised approximately $109.9mm from investors in six short years. On the other side of the spectrum, Purdue Pharma (now being reformed and rebranded as Knoa Pharma) continues its spiral into oblivion as key perpetuators of the opioid crisis.
Headlines from CNBC (2019) & The New York Times (2021).
So, what are the key differences between the startups that succeed versus the startups that implode?
The differences begin with the team's paradigm around vision, problem-solving, and transparency. It ends with establishing resilient accountability structures that bridge the company's internal decision-makers to external validators and strategic advisors. While there are few clear-cut answers in the startup realm, there are clear mechanisms for helping you navigate ahead when the path forward becomes murky.
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1) Vision Statement: What Do I Stand For?
Before we go forward, let's be clear: having an ambitious, aspirational, and clear vision for your company, technology, and team is essential to success. Internal clarity is essential for de-risking your company's operations, even for something as vague as a vision statement.
A vision statement differs from your vision as a founder. Some life science and medtech startups I consult for initially respond to the question of 'What's your vision statement?' with their dream of having an eight- or nine-figure exit. That's not a vision statement.
This leads us to the first of the key differences between startup successes and scandals - the founder's focus on financial outcomes over operational milestones.
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Both Theranos and uBiome were reportedly driven by aggressive investment and sales targets that encouraged unhealthy business practices. By prioritizing financial outcomes over operational milestones, companies are tempted to step out onto the market too early. When they do, they obfuscate what they have now for what their product may potentially be able to do with further development.
These companies had vision statements that claimed company operations would support patients. Obviously, these failed to align in reality. That says that they understood what their product could do, but not the principles by which they would make their dream a reality.
Writing a vision statement is not a 'check-the-box' marketing exercise. It defines the principles with which you will operate your company and stipulates a common goal for you and your employees to follow. Below, we have provided a template to help you identify what is most important and link the pieces together:
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Step 1 (Output): What are the products and/or services you will be providing? Through what mechanism(s) does your company hope to serve stakeholders?
Step 2 (Aspiration): What is your greatest ambition for the company? How will you positively change the people you serve?
Step 3 (Who): Who will you be serving through your products and services?
Step 4 (Principles): What is the emotional connection between your goal and how you do business to achieve it that needs to be clearly stated?
It's worth pointing out that major pharmaceutical companies like J&J and BMS have comparatively vague vision statements. When you have a portfolio of dozens products and compounds, your branding takes on a different tone and tenor to speak to a broader set of initiatives. As a startup founder, your responsibility is to make sure your story is as clear and accurate as possible.
2) Pivoting: Walking the Walk
Of course, it's not enough to have a story. You have to live by it. Upholding these principles doesn't just happen in strategy meetings - it happens while working through day-to-day challenges and major organizational pivots.
Startups have to pivot on a day-to-day basis. Initiatives rarely go to plan. For instance, studies tend to take more time and cost more than budgeted; feedback from advisors and investors is often constant and contradictory; driving towards an MVP seems like a never-ending marathon. Moreover, development often requires iteration to either reach your envisioned end product or to solve for unexpected issues. Coupling these challenges with a constant need for (more) funding and multiple initiatives to juggle at once forces companies to make difficult choices in real-time.
This leads us to the second of the key differences between startup successes and scandals - the ability to look at challenges as opportunities, rather than obstacles in front of what we want our product to be.
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If a company's vision is a promise, pivoting is recognizing that there is more than one way to achieve that promise. Failing to acknowledge that fundamental technological, financial, and/or operational changes are needed can send your company down a dark path.
Both Theranos and uBiome executives reportedly discussed the need to narrow their claims and focus on specific technological improvements with colleagues; the failure of those executives to recognize that pivots were needed appears to be both a function of ego and poor planning.
Achieving these requires a strong foundation rooted in culture and operational strategy.
Pivoting successfully requires three specific components (as shown below):
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Step 1 (Executive Planning): Create detailed product and corporate development plans, including all the 'little' steps needed to get from Point A to Point B. Gannt charts in Excel are often an easy way to add rows and map out progress over time. Key self-check questions include:
What are the discernable endpoints that you're targeting, and for when?
Is each step feasible for you to activate at present? What resources do you need (finances, time, talent) to achieve these changes?
Have you identified the individual phases of development (for instance, if you're building an app, what features will your MVP have? How will the first prototype differ? Are you cramming too much into each step)
Step 2 (Clear Articulation): When changes to your plans need to be made, they should be justifiable based on direct evidence and/or advisor feedback. However, many startups executives fail to explain key pivots, which can slow timelines due to confusion or employees not pursuing the new direction. While successful startups cannot be run by democracy, it is the leader's responsibility to direct their colleagues by answering these questions:
Have you identified the cause of the problem and why the current plan or paradigm is insufficient?
Have you identified a feasible pathway or solution?
What are the notable direct and indirect costs of shifting to this new approach?
Step 3 (Discussion Culture): More often than not, startup founder's knowledge extends a mile wide and an inch deep. Leveraging employees as subject matter experts is critical at every stage of the planning and pivoting processes. Given that they are working on specific areas of the company, they will often be the first to encounter and identify challenges. As such, creating a culture of internal transparency is essential to pivoting when possible, and 'failing fast' otherwise. Key self-check questions include:
Have you given employees a chance to bring their concerns to you (privately and publicly)?
Have you asked for solutions from a wide array of colleagues?
If potential solutions conflict with your vision for the technology or company, have you developed a comprehensive pro/con list to help objectively evaluate your options?
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It may seem like sticking to your original plan is a far cry from fraud. However, failing to acknowledge the failings in your plan and product crosses the line from the risk typically associated with startups into the territory of willful ignorance. Simply put, pretending things are okay internally may help you get closer to selling externally - but it doesn't solve the problems.
As we mentioned above, purposefully misrepresenting the nature of a product or service is one of the key components of fraud. When patient lives are on the line, this can lead to significant suffering.
3) Internal & External Transparency: Showing Your Hand
So, you have a story. You've created a company culture where colleagues can bring you their challenges, and you can collaborate to balance your vision for the company with the plan you've laid out to reach it. You're able to solve these challenges and tweak your plans before challenges metastasize.
This is all happening at light-speed. Until something happens that you can't immediately work around or put off solving until your next funding round.
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It might be a notable flaw in your product. It might be misinterpretation of a claim receiving scrutiny by regulatory bodies or insurance companies. It may even be that you'll be out of money before enough evidence is generated for another funding round.
This leads us to the third of the key differences between startup successes and scandals - the ability to be transparent, internally with colleagues and externally with investors, advisors, and customers.
Companies like Theranos and uBiome were notoriously siloed, which made it easier for problems to persist (and harder for whistles to be blown). Meanwhile, each company kept hawking their narratives to external stakeholders, who were none the wiser.
It's very likely that you will not be the first to know about these challenges. Respecting the expertise and authority of your subject matter experts (SMEs) creates a culture of transparency. This allows you to address problems head-on, rather than waiting for them to unexpectedly catch you off guard.
Image Source: QuoteFancy | Quote: Douglas Adams, 'Hitchhiker's Guide to the Galaxy'
It also allows you to get out ahead of the rumor mill by developing solutions before your colleagues perceive a major problem. Morale is the lifeblood of a startup - especially when you're working for equity.
External transparency is a bit more difficult to execute. Investors are aiming to maximize their investment - even if that means minimizing their losses. Startup founders are aiming to achieve their vision for the company alongside their own idea of success. Ensuring that these two parties work well together is critical to satisfying mutual interests.
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However, the human elements in play can be more difficult. No one likes to admit they made mistakes - whether those mistakes were believing in someone who could fail you or a more basic technological error.
With that in mind, here are a few steps and reflection questions for guiding complex discussions with investors. Remember, the goal here is not to obfuscate - it is to acknowledge and work through the problems to ensure the success of your venture and uphold the principles to which you've committed.
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Step 1 (Tell Them ASAP): Bringing challenges to investor's attention quickly are critical, especially when they represent a fundamental threat to the security of your business.
Do you understand what the problem is and how it was able to arise?
How significant is the problem to the survival of the business?
How long ago did your colleagues identify the problem? When was it brought to your attention?
Step 2 (Be Honest and Prepared): When you set up the investor meeting, don't dance around the issue. Be ready to present the full timeline, and come with solutions.
Do you have the appropriate amount of data to show what happened and a clear sense of what you do not know?
What are the short-term corrective actions? What are the long-term preventative actions?
How will this affect the timelines and projections of the business?
Step 3 (Establish Next Steps): Be prepared for investors to come back to you with questions and alternative ideas after the meeting. Remember, they're just hearing this for the first time. It's important to try and leverage structure to your communications for legal reasons and operational efficiency.
Do you know what your timeline for next steps is, and what those next steps are?
What can you do to mitigate short-term and long-term risk in the next 24 hours?
What is the optimal two-way communication mechanism you plan to keep open communications as the situation evolves?
With customers, the discussion becomes decentralized and notably more complex. There are many resources available that explain how to mitigate risk and manage these setbacks operationally. However, the gold standard case study is undoubtedly the J&J Tylenol recall in 1982 and 1983. Following the deaths of several patients due to the tampering of packaging and the addition of the poison strychnine to bottles, J&J recalled and destroyed approximately 31 million bottles. This unprecedented endeavor cost an estimated $100mm.
There is no doubt that J&J had the resources to do this and survive in the short-term. They are venerated in homes and praised on the market because they upheld their values and planned for the long-term.
Simply put, when challenges arise, will you be the last to know or the first to speak up?
4) Listening: Building Bridges with Advisors
As a startup executive, it's not uncommon to feel that the entirety of the company's welfare is on your shoulders. While early-stage ventures operate with small teams, there is a plethora of mentors and advisors available to help you through the technical, operational, and emotional challenges of building a business.
The fourth of the key differences between startup successes and scandals is the ability to solicit and implement advice from advisors, even when it requires massive pivots.
It is your responsibility to build those bridges and use them to circumvent impasses. Here are several types of individuals you can leverage for advice:
Investors: Good investors provide funds. Great investors provide partnership to support your venture's success. Clear and consistent communication is critical to developing credibility needed to engender confidence to face challenges. Plus, they are often well-connected, which means that they can help find answers they don't already have on their own.
Scientific Advisors: Solicit advice from the experts regularly, especially when designing experiments or issuing public-facing documents. They not only provide credibility on paper, but can help you navigate questions from customers and media.
Board of Advisors: Even in the startup world, you have bosses. In this case, you chose them to provide advice, so be sure to take it. These are your closest internal confidants.
Mentors: Find experienced entrepreneurs or other people who know you well that can provide rational, unbiased advice.
Therapists: Running a startup can be an emotionally taxing venture. Leveraging professional help will serve as a safety valve and represents a major opportunity for personal growth.
Lawyers: The law is a complex tool for defending your venture and understanding areas of vulnerability. While they may be expensive, they are an essential part of your success. Many formal accelerator and incubator programs have law firms contracted for a specific number of pro-bono hours per year, and some firms take equity if you meet their valuation criteria.
Consultants: The jacks-of-all-trades are able to offer specific subject matter expertise or broad strategic advice. Determine that they offer the level of expertise and credibility you need and make sure that you can provide them the access to information they need to succeed.
Regulatory Experts: Specific titles may fall into several of these previous categories, but that makes this area of expertise no less critical for life science and medtech ventures. You can also leverage discussions with the FDA in certain instances to guide your strategic planning, as we discussed in this post.
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There are two caveats to making this work. First, avoid sycophants. Find people who are willing to rationally assess the situation through questions and thoughtful discussion over people who are willing to agree outright. Second, incentivizing these advisors is essential.
These do not only come in the form of funds or equity - it comes from generating buy-in. No one enjoys having their opinion ignored. While this does not mean you have to try and satisfy everyone's vision for your business, it is critical to build trust through involvement. In return, they will help you build out the business operations and emotional safeguards needed to make your vision a reality.
5) Sales: But Wait, I Still Need the Money!
Sales is the oxygen that companies need to survive. Founders sell their idea (literally and metaphorically) to investors in exchange for equity and/or debt. Customer sales reflect customer investment, which is among the most significant KPIs for valuation and future growth potential.
It's dangerous to try to sell too much, too quickly. There are times where delaying product launch can be preferable to selling early, especially if the technology needs additional validation to back up formal marketing claims and/or what those claims imply. You cannot have a successful life science or medtech product without thoroughly validating the underlying technology.
This brings us to the final of the key differences between startup successes and scandals - balancing what the customer wants to hear with what the product actual does and can feasibly provide within the confines of legal, regulatory, and ethical boundaries.
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Put another way, how do you determine how 'sales-y' you can be? With investors, there are short-term and long-term costs of your promises. If you overpromise and underdeliver, you will lose credibility and damage the ability to raise future funds. Underpromising can limit the amount of money you're able to raise in the short-term and lowering your valuation without maintaining control.
With customers, every brand interaction is an opportunity to gain an inch or lose a mile. Setting aside the real potential fraudulent claims have to directly damage a patient, the indirect costs of unexpected side effects or misinformation from a test can have life-altering repercussions.
Once again, Theranos and uBiome epitomize this key pitfall in both their investor-facing and customer-facing materials. Eventually, it caught up to them in the form of negative press, and lengthy legal proceedings.
There are three key questions you can ask yourself and your team to guide your sales thinking:
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Step 1) What are you selling?: Be clear about what the purpose, function, and functionality of your product is upfront. Consumers should be able to make an informed decision based on your marketing information, even if they are not subject matter experts. Leveraging iterative storytelling with interactive glossaries, multimedia explanations, and live Q&A functionality or an FAQ section are best-in-class tactics to balance marketing objectives with the realities of your product.
Step 2) How you selling it?: Be clear about who the product is for, when, and where else they can look for additional validation (such as their doctor). Further, try to limit promotional terms that could overstate the efficacy or accuracy of your product.
Step 3) When you selling it?: Be sure that patients know whether or not this has been approved by a regulatory body. If it is a broad diagnostic test (such as a blood or microbiome test), be sure to know what the presence or ratios of certain biomarkers tend to mean - if you cannot, it likely means more basic research is needed. If you're working with investors, be honest about where you are and what you believe will be critical to helping you get there.
Of course, this is just the start. As we discussed previously, leverage your advisors, consultants, and lawyers (especially lawyers) to mitigate your risk.
Founder, Heal Thyself
With all this in mind, there is one difference between wasting money and investing in a startup.
Investing in a startup demands a certain degree of risk, but that risk is hedged through clear, open, and effective communications from the moment the company is founded.
Wasting money involves investing without regard for risk and limited operational oversight to ensure that business is being carried out properly, ethically, and within legal boundaries. Failing to do these things encourages fraud, and the harm it brings to those stakeholders who believed in you.
Theranos and uBiome are not new stories. More importantly, the challenges and circumstances which created them are not new either. We see that some form of fraud was allegedly committed thanks to several major strategic failures and numerous blind eyes. Each of these companies had powerful visions founded on serving unmet medical needs.
There are hundreds of startups every year that fold because they have hit an impasse they cannot surmount with the resources on hand and through ethical means. We idolize entrepreneurs who can beat the odds. They are rewarded for doing the impossible through fame, fortune, and the opportunity to do it all again.
With that said, there are too many patients in need and too few dollars available to justify millions of dollars of wasted funding.
There may be no facts about the future, but good work climbs the tightrope and the rest falls away. The high-risk, high-reward nature of the startup world is no different, except to say that this quote by Douglas Adams (author of Hitchhiker's Guide to the Galaxy) particularly applies: 'Nothing travels faster than the speed of light with the possible exception of bad news, which obeys its own special laws.'
Eventually, it all catches up to you.
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