Outside the Box: How investors can prevent another Theranos from blowing up their portfolio

Elizabeth Holmes, the founder of now disgraced blood-testing company Theranos, really isn’t so different from other entrepreneurs whom investors have lionized and revered for the ability to “pivot.”

Holmes, now charged with “massive fraud” by the U.S. Securities and Exchange Commission, started with an exciting premise passionately delivered — and then discovered why her first idea was doomed to fail. Her response was to perform a song and dance for investors to continue to raise money so the company could build its product 2.0. Had things gone differently (and had she not lied and hid the truth — for which she is rightly being pilloried), Holmes could have become a hero.

Theranos claimed its technology would revolutionize health care. Holmes told investors Theranos’ blood-testing technology would be “faster, cheaper and more accurate” than alternatives, and that the U.S. Department of Defense had used the tests on the battlefield in Afghanistan — a claim the SEC says is false.

Investors aren’t going to stop making bets on the next potential disruptive technology in health care. The potential prize is too great: biotech companies are getting snatched up every month for anywhere from hundreds of millions to billions of dollars. And these are companies that don’t have cash flow and aren’t valued on multiples. They promise disruptive science that will ultimately improve and extend people’s lives — heady stuff that can generate 10X returns.  

Academics and scientists both are subject to pressures to constantly publish new findings and provide novel breakthroughs. How do investors know whether the findings are real and worth their money? How can investors make big bets in health care while protecting themselves against the kind of flame-out that Theranos’ big-name funders are living through now?

According to recent research, “more than two-thirds of researchers have tried and failed to reproduce another scientist’s experiments.” If Theranos teaches us anything, it’s the degree to which investors need to verify published research, particularly in the bioscience and health care spaces.

According to anonymous surveys, only 1%-2% of scientists admit to having fabricated data at least once. Bigger culprits of irreproducible results might appear in other ways, such as dropping certain data points or failing to publish contradictory or null results. Most of the time scientists believe in their results and will never know why they can’t be reproduced in third-party or academic spinout’s labs.

As we’ve learned from Theranos, understanding as much as possible about the academic’s breakthrough is a critical step when investing in the biosciences, so finding ways to obtain some third party validation early and efficiently, can be a game-changer for venture capitalists.

Firms like Atlas Venture have shown that de-risking biological investments early — in the seed stage — can have a huge impact. Atlas has achieved a 10% loss ratio (nearly 20% lower than the norm in biosciences) in part by encouraging truth-seeking behaviors and testing early on, even when it means killing a promising product. As Bruce Booth, a partner at Atlas, writes for Life Sci VC, “Don’t power up the story until the early biologic risk is wrung out.”

Investors, academia, government and industry must work together to advance the academic discovery further along in the commercialization process. The NYC Early-Stage Life Sciences Funding Initiative is one public-private partnership helping to translate cutting-edge academic research into breakthrough biological products. The fund helps to identify promising research and sets in motion a vetting process upfront.   

My firm, Connecticut Innovations (CI), with our $200 million biosciences fund, provides another excellent model. In one example, CI, Yale and UConn are funding Craig Crews’ PITCH program at Yale University and UConn to help statewide academics work with third-party faculty to advance discoveries. By the time the idea is presented to investors, venture capitalists have already determined the biological risk. And academics who aren’t familiar with the entrepreneurial process receive the right guidance to turn their research into a viable, commercial product.

The Theranos story offers investors important lessons that will push the life-sciences industry closer to commercializing breakthroughs with greater frequency and greater success.

Prioritizing investments where the results are verified independently (or at least understanding a blind spot), instituting processes that de-risk biological research, and creating organizations which help to translate academic research into commercial ventures are now being done for the first time. When I was at Columbia University in the early 2000s, spinning out companies based on Columbia discoveries and IP, investors relied on published papers, patent applications, and the power of the celebrity scientists.  Now, venture investors can and should demand more.   

Matthew McCooe is CEO of bioscience venture-capital firm Connecticut Innovations .

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