David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.
Venture capitalists and other investors always are on the lookout for the next hot technology startup, hoping for huge profits from initial investments in companies such as Google, Facebook, Uber, Airbnb, and Lyft. But they know that for every successful technology startup, they will have potentially invested in a dozen or more startups that fail.
Since everyone is watching for the technology startup that will “hit a home run,” these investors are willing to throw significant money into technology startups that promise to “shake up the industry” with a significant “paradigm shift.” It therefore shouldn’t be surprising that fraud has found its way into technology startups. I will be discussing various aspects of technology startup fraud over the next two weeks.
Let’s start with Theranos. Founded in 2003 by then 19-year-old Elizabeth Holmes, Theranos was touted as a breakthrough technology company that claimed to have devised a blood test that only needed very small amounts of blood. Theranos raised more than $700 million from venture capitalists and other investors, reaching an estimated value of $10 billion between 2013 and 2014. Theranos persuaded Safeway, Walgreens, GlaxoSmithKline, Pfizer, the Cleveland Clinic, Capital BlueCross, and AmeriHealth Caritas to partner with it in various ventures between 2012 and 2015. Theranos was also awarded the 2015 Bioscience Company of the Year by AzBio.
However, in October 2015, The Wall Street Journal reported that Theranos was using traditional blood testing machines to run its tests instead of the company’s own machines, and that the company’s machines could provide inaccurate results. This article prompted increased scrutiny and investigation from various Federal and state agencies over the next three years. By September 2018, Holmes and the company’s former president had been indicted on multiple counts of fraud, and Theranos had become worthless – a loss of approximately $700 million.
Mozido is similar case. Founded by Michael Liberty in 2004, Mozido and its predecessor companies claimed to offer a mobile payment application that could be used with any mobile phone ever made. These claims allowed Mozido to raise over $300 million from venture capitalists and other investors, reaching an estimated value of over $5.5 billion in 2015.
As with Theranos, Mozido was done in by a media report – in this case, an August 2016 article in Forbes which questioned Mozido’s technology and suggested that significant amounts of investment capital appeared to have been diverted for Michael Liberty’s personal use. Last month, Michael Liberty was indicted for defrauding investors.
So, what are the characteristics of technology startup fraud? Let’s turn to the Fraud Triangle as described by the Association of Certified Fraud Examiners (ACFE). As you may recall from my past blogs, the Fraud Triangle consists of three “sides” – Pressure, Opportunity, and Rationalization – all of which must be present in order to facilitate fraud.
Pressure for technology startups comes from venture capitalists and investors who demand hyper-growth and immediate value. Additionally, once a startup’s proposition (such as innovative blood testing or a mobile payment app that works seamlessly across multiple mobile phones) becomes attractive, competitors begin to occupy the same space. This, in turn, creates a race to become the first to actually introduce its product to the marketplace. The race quickly burns up funding, placing increased pressure on the startup to raise more money.
Opportunity arises from the ability to self-report and promote progress and to issue unaudited financial statements not subject to oversight or verification. Additionally, startups which can raise large amounts from venture capitalists and other investors are able to stay private longer, and therefore delay transparency. Finally, the media can become complicit when hot companies provide only self-reported scraps of information which form the basis for further “hype.”
Rationalization comes from founders and entrepreneurs, who are taught they should change the world, move fast and “break things.” This makes them think they should be able to take shortcuts and ignore the rules. Indeed, a common belief by such fraudsters is “fake it until you make it.”
Next week’s blog will discuss the specifics of how Theranos, Mozido, and others technology startups were able to perpetrate their frauds as well as pointing out some red flags that could indicate a potential technology startup fraud.
Information on fighting and preventing fraud is available from a Certified Fraud Examiner working with an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley. The Philadelphia forensic accounting firm of David Anderson & Associates can be reached by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.
About David Anderson & Associates
David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley. The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting, and outsourced CFO services. Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.
