A recent investigation of the Silicon Valley “sweetheart” Theranos looks into what representations its founder, Elizabeth Holmes, made to investors and whether they amount to misrepresentation. This headliner gives us a great opportunity to discuss the issues surrounding the Theranos investigation and misrepresentation of investment.
Misrepresentation in this context comes about when a company or startup knowingly makes a false statement of fact to investors for the purpose of causing them to invest. You can read all about the difference between fraud and misrepresentation here.
While we wait to see what the investigation unfolds, many are wondering what the big deal is. An investment is always a risk isn’t it? Isn’t it a known risk that a company’s profits won’t pan out the way the business plan projected they would? Or that a business’s model or technology won’t develop or prove to be as useful and in demand as we hoped?
These are all great points, but the issue is not when a company fails to do what it was trying to do. Like turn a profit within one year or offer the next best gadget Silicon Valley has to offer.
Rather, the issue is when a company fails to do what it promises it would do. All too often, startup founds find themselves desperate enough to generate revenue that they give the numbers a little artificial boost. They inflate the profitability a smidgen. They might even make a bold statement about the quality of performance of the services they intend to provide. Some of these acts may amount to fraud or misrepresentation.
While super ambitious goals may sound a lot like a fraudulent promise to make more money than you really can, there are some real differences. When a company makes the kinds of promises that Theranos made (think: best technology that can do ten times what competitors do at a fraction of the cost), the company better know 100% that it is able to follow through. If they aren’t sure of the factual basis, and you can prove it, they may be fraudulently misrepresenting the outlook of the investment.
If you are ever being pitched an investment that sounds too good to be true, remember: an ounce of prevention is worth a pound of cure. Some naïve investors give money to startups thinking, “I’ll get my money back if the claims turn out to be untrue—it’s illegal to lie after all!” The sad reality is it is extremely difficult to prove fraud and oftentimes, the startup will enter bankruptcy by the time you get a judgment against them.