The Problem With Unicorns

A new book by the Wall Street Journal’s John Carreyrou, Bad Blood: Secrets and Lies in a Silicon Valley Startup, works as a compelling test case in how the hunger for the next “unicorn,” a hunger that has been a feature in alternative investing for years now, can go badly wrong.

The term “unicorns” in this sense, is one that caught on after it was bestowed on promising Silicon Valley startups by venture capitalist Aileen Lee four years ago. It is very tempting to chase a start-up that looks like it might be the next unicorn precisely because they are not legendary creatures, exactly. Spotify was real. Uber was real. The early investors in each of those have been rewarded to a degree one might well consider magical. Unicorns are not legend, but the temptation to believe that some very ordinary nag is actually the next great unicorn is very powerful and dangerous.

The chase for unicorns in recent years bears some resemblance to the dot-com craze of the 1990s, but there is as Carreyrou observes an important difference.  The unicorns of the second decade of the new millennium have been in no hurry to get onto a stock exchange and enjoy that “pop.” They prize their unlisted status and the extra flexibility it allows management.

And seekers of alpha are willing to accord them that extra flexibility. Carreyrou says that it was around 2010 that “the managers of East Coast hedge funds that [had] normally invested only in publicly traded stocks” started making a pilgrimage west “in search of promising new opportunities in the private startup world.”

Elizabeth Holmes became one of the oracles visited by such pilgrims. Theranos (a portmanteau of “therapy” and “diagnosis”) became a temple. At its peak, through the years 2013-14, Theranos was valued at more than $9 billion.

Disruptors and Magic Tricks

A buzzword prized in recent years, almost as highly as “unicorn,” is the related term “disruptor.” Magical levels of alpha are to be reached not by working aggressively and well within the existing rules of an industry or marketplace, but by disrupting them. And Theranos promised to disrupt the world of diagnostic lab testing, beginning with hematology.

At a simple human level, the level of the everyday patient: nobody enjoys going to a lab to have a technician search for a "good vein" inside the elbow. Some people are cursed with veins that don’t make this search easy, and they have to sit their patiently through repeated efforts. Some people are afraid of needles. Even for the least squeamish, the whole ritual is an uncomfortable one. This is what Theranos offered to disrupt. It was selling itself as the marketer of a new technology that could get the same results from a mere finger prick.

As Carreyrou describes, potential investors visiting Theranos’ headquarters were given a show. In the early years of the company (2003-06) it was one of the co-founders, Shaunak Roy, the holder of a Ph.D. in chemical engineering, who would preside over the demonstration. He would prick his own finger, milk a couple of drops of blood, and transfer that blood to a small container about the size of a thickened credit card. Then Roy would slot the cartridge into a device about the size of a toaster, which they called the “reader.” The reader was supposed to transmit data from the blood to a server. The investors didn’t generally want to wait around for the results, and they were usually promised that the results would be mailed to them.  The underlying idea was that these readers could become appliances in the homes of health-conscious individuals, or could be loaded into the back of humvees in combat zones. The more general idea was that decentralized blood testing was about to revolutionize medicine.

Theranos certainly seemed like a unicorn. Theranos was also, as the world now knows (thanks largely to a handful of whistleblowers to whom Carreyrou reached out, beginning in February 2015) a fraud.

It was founder Elizabeth Holmes who became the public face of this company, especially after Roy’s departure. Like Steve Jobs, whom she admired and emulated (right down to stagecraft and turtlenecks), Holmes seemed to exude a “reality distortion field.” People around her lost their skepticism and come to believe implicitly in her vision. They would believe that her device could run 70 tests simultaneously on tiny drops of blood with a degree of reliability that would shame the labs.

But the claims were smoke and mirrors; the demonstration was a magic trick. The “results” that the subjects of the demonstrations did (sometimes) receive were generally obtained using quite conventional lab equipment, not the at-home reader readers that Holmes would talk up within the distortion field.