Your Cap Table Tells an Important Story. Is it the Story You Want Told? [Theranos Edition]
Do You Know the Story Your Cap Table is Telling?
The Elizabeth Holmes Theranos trial is underway, which has brought the story back front and center in the minds of investors - and what a story it is. Yes, there were plenty of underhanded things (and I mean plenty) that they did wrong. Plenty of things that they should (and most likely will) get punished for. However, that story has already been written. The book Bad Blood by John Carreyrou is a must read if you have interest in the topic.
However, the rise and fall of Theranos is a treasure trove of lessons for investors and CEO’s to learn - good and bad (mostly bad). In the autopsy that inevitably follows massive, high-profile frauds like Theranos, I think it is critical for CEO’s and Investors alike to take the time to study and learn the appropriate lessons. As the famous quote goes, “those that forget their history are condemned to repeat it.”
One important lesson to learn is to take a closer look at the Cap Table and Board of Directors that Theranos built. There are some very interesting things to look at there - both positive and negative.
“Part of what made Theranos such a big name in Silicon Valley was the people the company brought on for its board of directors. The company had notable figures from the worlds of both business and government as members of its board. They included: Henry Kissinger; Jim Mattis; George Shultz; Richard Kovacevich (former CEO of Wells Fargo); William Perry (former United States Secretary of Defense); and William Foege (former director of the Centers for Disease Control and Prevention).”
Investors Seek to Validate Your Company - Every Validation Point Counts, Even Your Cap Table
Investors are constantly seeking validation points for companies that they are looking to invest in. Their job is to turn over every rock, and search for any possible clue to help them determine the potential for the company to succeed. Most CEO’s understand the full scope of business validation metrics that investors review. There are the usual suspects such as number of customers, market penetration and adoption, revenue growth, etc. All of those are valid. However, many Founders and CEO’s may not fully understand that potential investors are also looking for validation on the cap table as well.
By all accounts, it would appear from the outside as if the importance of the company cap table was one thing that Theranos understood very well. In fact, it would appear as if they were masterful at creating an impressive list of investors and Board Members, and then subsequently leveraging the ‘star power’ of those names to raise additional capital. Set aside for a second (if you can) the nefarious purpose behind it, and you must admit that they were pretty darn good at this.
An article in Crunchbase recently published a deeper dive on the investor cap table that will help illustrate this point. As reported in Crunchbase: “Theranos raised about $1.3 billion in [equity] funding over the course of its history [more if you include debt]. Some of the most high-profile investors in the company include: Media mogul Rupert Murdoch; Venture capitalist and Draper Fisher Jurvetson partner Tim Draper; Oracle Executive Chairman and founder Larry Ellison; and National pharmacy and retail chain Walgreens [among others].” A pretty impressive list of individuals who have done quite well for themselves as investors.
However, Theranos did not stop there. They also carefully created a unique group of Board Members. As detailed in the article: “Part of what made Theranos such a big name in Silicon Valley was the people the company brought on for its board of directors. The company had notable figures from the worlds of both business and government as members of its board. They included: Henry Kissinger; Jim Mattis; George Shultz; Richard Kovacevich (former CEO of Wells Fargo); William Perry (former United States Secretary of Defense); and William Foege (former director of the Centers for Disease Control and Prevention).” Without question, this is an impressive Board, made up of some of the most successful and influential names in the country. Tough to refute that.
The Marketing Angle - The Cap Table Story Theranos Wanted Investors to Believe
It would appear as if Theranos clearly viewed their cap table and Board of Directors strategically. From the outside, the cap table and Board of Directors told an extremely powerful story. Names like Henry Kissinger and George Schultz carry a significant amount of weight. Obviously I was never in an investor meeting, but I am quite sure that those names were leveraged during pitch sessions.
Given their proficiency at raising investment capital, Theranos was clearly successful at using the cap table in order to convey a high level of validation for the company and its mission. The message they were sending to investors was: ‘These smart people invested in us. Therefore, it is safe for you to invest as well.’ What better way to keep new potential investors from performing deep due diligence. The assumption was that if these investors and Board Members trust Theranos, then other investors should too. While this fact alone may not have been the deciding factor in whether someone invested or not, I am sure that it showed up in the positive column.
For certain investors, the list of these names may have been all that they needed to see in order to make an investment decision. Once again, we don’t know this for sure - but it certainly helped.
The Investor Angle - The Story the Cap Table ACTUALLY Told
However, something was missing. That something was industry-leading healthcare investors. Theranos repeatedly declared that their mission was to disrupt and revolutionize the blood test diagnostics industry. Interesting then that there were actually no investors on the cap table that knew the space. There were no institutional-quality investors that actually have a history of successfully disrupting and revolutionizing the healthcare industry. Red flag.
Ironically, the same cap table that looked so strong for a certain group of investors, likely looked incredibly weak to another group of investors - namely institutional-class healthcare investors. The cap table was suspiciously missing names of institutional investors that had domain expertise in the industry. For a company to have reached the valuation level and market dominance that Theranos reached, it is highly unlikely that healthcare-related venture and private equity funds would not have been deeply involved. After all, who better to know the space and get involved early. Curios to say the least.
Why were those investors absent? Honestly, I don’t really know. Is it because Theranos intentionally avoided investors with expertise in healthcare? Was it because those investors looked at the deal and decided to pass? I don’t have that information. However, that should have been a serious red flag for anyone looking at the company. For investors that looked closely, I am sure that it was.
Don’t get me wrong - I have nothing but the utmost respect for individuals like Henry Kissinger and George Shultz. However, I am not about to hang my investment hat on their ability to understand the challenges and pitfalls that come with revolutionizing the blood test diagnostics industry.
Frauds like Theranos will always be with us - unfortunately. So let’s try to put aside all of the ugliness and see what we can learn. What are a few of the enduring lessons that we can take away from this?
The Lesson to Take Away for CEO’s/Founders
Your cap table is telling a very specific story to potential investors. Make sure it is the story you want told. If you are a growth-stage company or CEO, you need to understand that potential investors are scrutinizing EVERY aspect of your company. They are constantly and relentlessly looking for ways to validate or invalidate your company and your team. A solid cap table is a strong validation point - and sends a powerful signal.
To state it plainly - move heaven and earth to populate your cap table with strategic investors. That means investors that are leaders in your market. Investors that understand your space, and can help you attain the growth you seek. Investors that can help validate the direction your company is moving in. I have said it a thousand times before - forget the ‘dumb money'.’ It may help you in the short run - but ultimately dumb money won’t get you where you want to go. I fully realize that this is not the shortcut. Finding and connecting with this caliber of investor is the long, hard road. But it is a road worth traveling. You are already putting the work in to build a world-class business. The quality of your cap table is an important ingredient to that end.
The Lesson to Take Away for Investors
The cap table matters. It says a lot about how well the management team has thought through its strategic growth and funding plans. Clear, strategic thinking on the cap table is a positive sign for clear, strategic thinking for the business. As an investor, you want to invest alongside other investors that understand the space, can add business strategy validation, and can help the company become successful. ‘Dumb Money’ can’t do any of those things.
If you are a Growth-Stage investor, understanding the make-up of the current cap table is essential. You MUST understand the profile, biases, and needs of the investors that you are investing alongside. Ultimately will these investors support growth, or will they be a hindrance? At every strategic growth stage of the company, and certainly at every challenge point, a strong cap table filled with likeminded investors and industry experts is a vital asset to have. If it is not there - buyer beware.
Like Everything Else in Life - Strong Cap Tables are No Accident
It takes work - a lot of work and intention upfront to build a cap table that will help a company succeed. Building a pipeline of potential strategic partners is really no different than building a strong sales pipeline. Yet, for some reason, many Growth-stage companies view the two exercises in a completely different manner. However, that is a post for a different time. It is also no accident that targeting the appropriate potential investor is the 1st step in our Capital Strategy Program. Build with the end in mind. Create the investor list that will help your company weather the inevitable ups and downs, and then work backwards to build those strategic relationships.
If you are a Founder or CEO, what is the next step?
If you are a Founder/CEO and are getting prepared for an institutional capital raise - you probably have a lot of questions, concerns, and potentially some self-doubt right now. Maybe you have a pit in your stomach at the thought of the raise process.
Here is the good news - great ideas paired to a great business are still getting funded. The challenge is to create an effective story. One that investors fully understand and can get excited about.
That is where we come in. We have created several Workshops to help your growth-stage company effectively engage with the institutional investor community.
© Copyright September 2021. Marc Patterson. All Rights Reserved.
“A Closer Look At Theranos’ Big-Name Investors, Partners And Board As Elizabeth Holmes’ Criminal Trial Begins” by Sophia Kunthara, Crunchbase.com, 9.14.2021
