Fake It Till You’re Fraudulent
Photo by Tima Miroshnichenko
With the recent verdict against Sunny Balwani, the former Theranos COO accused of widespread fraud, the second shoe has finally dropped in perhaps the most notorious fraud case ever for a Silicon Valley venture-backed tech company. Like Elizabeth Holmes, his more infamous business and romantic partner, Balwani was found guilty of multiple counts of fraud.
While the Theranos scandal may have been an outlier, the conclusion of the case serves as a timely reminder that it is time to reel back one of Silicon Valley’s most deeply held beliefs: exaggerating our own hype.
The glorious retrospective back stories of successful Silicon Valley tech companies are rife with tales of hype far exceeding reality. From Apple to Amazon, entrepreneurs are taught the same lesson: if you want to make it big, you need outsized hype. You need spin to win. Building a company and gaining investors requires falling in love. Rarely does the pitch, in its stark, underwhelming near-term reality, smite potential investors, customers, and employees as much as the grand future vision does.
This tendency is encapsulated in terms frequently heard from incubators to cocktail parties in Silicon Valley. Entrepreneurs will admit to “vanity metrics”—statistics about their businesses that sound impressive but are often meaningless. Designed to convey an impressive level of “traction.” Young founders are encouraged to “fake it till you make it,” essentially to pretend they and their business are much more impressive than they really are with the hope they will “grow into the story” over time.
Almost every founder weaves an outsized tale of their company’s momentum and potential. As a multi-time founder and senior marketing executive at various tech start-ups, I’ve certainly been the one responsible for generating that hype at many points in my career. Belief—even when there are few facts to support it, even when all the evidence is to the contrary—is essential to the success of any start-up company. If you allow yourself to be overly burdened by what is, you’ll drown. You need to focus on what will be, and the path for getting there—not only for investors, customers, and employees, but for yourself. The decision to found or join a start-up is, in most cases, an irrational one, fraught with risk. The hype helps you muster the enthusiasm to overcome those insurmountable odds.
Venture investors, for their part, also deserve their share of blame for Silicon Valley’s hype hyperinflation. Despite their reputation as clear-headed financiers, VCs can be surprisingly prone to believing their own hype. One prominent Silicon Valley VC once privately admitted to me he decides on an investment in the first 5 minutes of a pitch, then everything else is seeking affirmation to justify that impulse decision. Once the investment is made, VCs have even more incentive to grab on to any proof point, anecdote, or vanity metric they can in an effort to hype up the company to other investors, tech media, recruited executives, their own partners, and everyone else in the ecosystem who needs to be fed a story. Venture investors arguably have a pronounced conflict of interest when it comes to their fiduciary responsibilities. As board members, they ostensibly provide oversight, but, in reality, they need new downstream investors, acquirers, or the public markets to believe the hype in order for their investment to appreciate and achieve an exit.
When founders and investors align in a self-perpetuating, white-hot hype echo chamber, the results can be disastrous. This proclivity for exaggeration over transparency, spin over substance, hype over diligence creates a slippery slope that can tip into outright lies and even fraud. The reality never catches up. My upcoming novel, Bit Flip, dramatizes just such a scenario. What starts out as liberal revenue recognition, escalates into falsified accounts, and, ultimately, outright fraud within the protagonist’s start-up company—putting him in a moral dilemma about what to do about it. Although fiction, the situations, incentives, and escalations of the story are all too real.
When this situation happens in real companies, it usually breaks one of three ways:
Scenario 1: By far the least likely outcome, but the one we all love sharing examples of, is the company actually does live up to the hype. We love this outcome. The one-in-a-million exception that rationalizes the practice. The extreme outliers that all others try to emulate. The “aw shucks” and “remember when” stories that get told in memoirs and biographies. Yours is most likely not this company.
Scenario 2: For the vast number of start-ups in the middle of the bell curve, at some point, the hype bubble bursts. Investors actually ask the tough questions, dig into the details, look under the hood. They realize that they need answers to the questions they’ve been afraid to ask. That spin and hype have become self-delusional. This is the “come to Jesus” moment for many start-ups, when they simply can’t take another sip of their warm, saccharine Kool-Aid. Down rounds, founder swaps, and employee layoffs are a best-case scenario. Some of these companies manage to get their act together and traverse the painful path back to reality. But the vast majority are too far gone. They’re end-stage.
Scenario 3: At the other extreme of the spectrum lie the equally fascinating implosions. The companies that reach a point where the hype has become so outsized, so metastasized, for so long, and so completely detached from reality that they are poised for catastrophe. The Theranoses of the world. The companies who “faked it” till they were fraudulent. Though convicting founders of criminal fraud, as in the Theranos case, is rare (recent charges brought against the CEO of electric truck maker, Nikola Corp notwithstanding), incidents of self-dealing, dysfunctional work environments, and unethical business practices abound—see WeWork, Zenefits, Uber, and many others. High-flying media darlings that plunge to earth so spectacularly that we can’t look away.
With the days of free-flowing venture capital waning, we may see a commensurate balancing of hype with reality. As we’ve seen in past economic cycles, corporate fraud which can proliferate in boom markets often gets exposed when the financial tide recedes. The ensuing fiscal conservatism can temper the grow-at-all-costs mindset. As more tech companies are forced to hunker down for the first time in over a decade, it’s a moment to recalibrate and make sure their reality really can keep pace with their hype.