A Cult of Personality Blinded Others to Their Schemes

Today's blog is long but comprehensively addresses two of the most interesting cases of how not to run a business. For educators, it could be the makings of a case study to use in the classroom.

I recently watched a streaming video (Apple TV) of the financial mess at WeWork and the role of its CEO, Adam Neumann, as well as a documentary on the company’s decline. I also watched the Dropout, a streaming video (Hulu) on the rise and fall of Elizabeth Holmes, who was the founder and CEO at Theranos, and I watched a documentary as well. I did find the streaming shows represented reality.

Visionaries and Innovators

WeWork and Theranos were led by CEOs that had "ambition, drive, vision and optimism, which are all part of the Silicon Valley ethos,” venture capitalist Greg Gretsch wrote on Twitter. “Outright lies and deceit are not. Fraud is fraud.” 

Both companies were run by engaging CEOs who were viewed as visionaries and innovators, and that helped them to raise capital from investors and keep the money flowing even after it was obvious both companies were in financial trouble and flirted with bankruptcy.

I call it a “Cult of Personality,” whereby an infectious leader rounds up the troops to work for their companies, creates the vision of making a kinder, more engaging work experience, and develops a cult like following by the employees, who felt lucky to work for these companies. Both Millennials and Generation Z workers bought into the dream that what they were selling would significantly improve working conditions (WeWork) and revolutionize the health care industry (Theranos). The problem was the hype was greater than reality and each CEO built a house of cards that inevitably would collapse.

Key Strategy

As an office space start-up in 2008, WeWork rented a few floors of a building from a property manager in a high-density urban area. It reconfigured the space to include a mix of private offices, conference rooms, lounges, and open workspaces and adds a variety of worker-friendly value-added features, such as coffee, office supplies, and beer on tap. Rather than just renting desks, the company aimed to encompass all aspects of people's lives, in both physical and digital worlds. This included expanding the WeWork model to residential housing and education, two areas that fell by the wayside as the company fought off bankruptcy.

The name Theranos was derived from a combination of the words "therapy" and "diagnosis." In 2014, Theranos, a blood-testing startup pitching a supposedly revolutionary technology, was flying high. While existing technology required one vial of blood for each diagnostic test conducted, Theranos claimed to be able to perform hundreds of tests (supposedly over 240) ranging from cholesterol levels to complex genetic analysis, with just a single pinprick of blood. Automated, fast and inexpensive, Theranos seemed to be offering technology that could revolutionize medicine and save lives the world over. 

Disruptors

In both cases, the CEOs were seen as “disrupters” in their field. They aimed to do something that other companies were not or could not do. Disruptors are companies that have the potential to change or entirely displace existing companies and industries. These companies can have innovative technologies or operations that are more efficient or make the old way of doing business obsolete.

The CEOs were also considered “unicorns,” because having them as the fearless leader was highly desirable and it was hard to find others who could lead their companies to stardom.

Both CEOs were “zealots.” They were uncompromising when it came to their plans and others became worshipers of the person and the dream. Adam Neumann was seen as messianic while Elizabeth Holmes was seen as kind of goddess.

It also helped to sell outside investors on their idea even though, in the case of Theranos, a small machine, dubbed the Edison, could not meets its promise that drawing blood from a simple finger-prick would revolutionize blood testing. It was supposed to allow people to do blood testing at home. The only problem was it didn’t work. Moreover, the company constantly made excuses for not showing investors and retailers how the equipment worked.

As the New Republic reports, WeWork's CEO, Adam Neumann, and his wife, Rebekah, were "strategic thought partners" at the company. They held a position requiring little or no work but giving them status or financial benefit. Neumann’s tendency for the excesses of start-up culture and his dubious business acumen fixated the financial press for years, and in the end Neumann and his investors squandered billions of dollars with few consequences for themselves other than some reputational damage (or free publicity, depending on your perspective).

The Role of Venture Capitalists

Both companies were grossly overvalued in large part due to the hype and ability to get venture capitalists to buy into the dream. In the case of WeWork, they developed a new way to measure earnings called “Community-Adjusted EBITDA.” EBITDA stands for earnings before interest, taxes, depreciation and amortization, a calculation used as an alternative way to measure earnings but is not consistent with generally accepted accounting principles. To my knowledge, there were no companies using the term “community” in their measurement of EBITDA. WeWork was not a public company, so it didn’t have to disclose how earnings would have been calculated under generally accepted standards. I call what they did “financial engineering.”

WeWork CEO, Adam Neumann, was portrayed as an engaging individual, very likeable, and had the ability to convince investors and venture capitalists that WeWork was revolutionizing workspace for companies and providing a fun filled, healthy environment within which to work. He even convinced Masayoshi Son, the billionaire and savvy investor-owner of Softbank, to invest $4.4 billion in the company. Softbank initially valued WeWork at $47 billion, but that dropped down precipitously to $2.9 billion as the troubles at WeWork became public.

Eventually, Softbank bought out the shares owned by Neumann and the former-CEO walked away with a $480 million severance package.

Fake It Until You Make It

Holmes was adept at faking the results to move towards her goal of blood testing dominance. Following repeated attempts to get their blood-testing equipment to work, Holmes started to use the commercial blood testing equipment of other health-care companies, including Siemens, to process the blood. Rather than being able to process blood samples for testing using just a drop of blood, which was its mantra but unworkable, Holmes started to say the company needed droplets of blood to do the testing.

Holmes successfully convinced Walgreens to jump on the bandwagon and set up wellness centers for customers in Arizona to have their blood tested in the stores by the Edison, which didn’t work and sometimes gave false results that jeopardized the health of users of the equipment. Walgreens eventually walked away from its $50 million investment in the company. 

After years of deceiving the public and venture capitalists, in 2016, Erika Cheung, a disgruntled whistleblower, contacted the Centers for Medicare and Medicaid Services (CMS) about the inability of Theranos to deliver on its promises and false results. The CMS revoked the Clinical Laboratory Improvement Amendments  (CLIA) certificate of Theranos’ Newark, CA, laboratory and banned Holmes from owning, operating, or directing a lab for at least 2 years.

Theranos said it will not conduct any patient testing in that lab “until further notice” and promised to work with the agency to address problems with the Newark lab—while continuing to serve customers through its other lab in Scottsdale, AZ.

It was just a matter of time before former employees contacted a Wall Street Journal reporter, John Carreyrou, who wrote an expose about the failures that opened the eyes of investors, venture capitalists, and board of director members to what was really going on at Theranos. Carreyrou wrote a book about it titled Bad Blood.

Legal Issues

Elizabeth Holmes was found guilty on four counts related to defrauding patients who had used Theranos’s blood tests. The jury was unable to reach a verdict on three counts of deceiving investors, for which Judge Edward J. Davila of California’s Northern District said he planned to declare a mistrial. Each count carries a maximum sentence of 20 years in prison, terms that are likely to be served concurrently. A sentencing date has been set for September 2022. Holmes is expected to appeal. Holmes’s chief operating officer and lover, Sunny Balwani, who essentially ran the day-to-day operations, is currently on trial for his role in the fraud at Theranos.

As for WeWork, it hired a new CEO and reconstituted the board of directors, opening the door for the company to issue an initial public offering (IPO). Adam Neumann was never charged for his role as a co-founder and CEO of the company.

The employees of both companies had to sign “non-disclosure agreements” (NDAs,) which in the case of Theranos was necessary to stop anyone from talking about the failed equipment and unsuccessful process of evaluating the health of an individual from a small quantity of blood. Nevertheless, the two whistleblowers did eventually go public and that helped to bring down the company.

The Edison didn’t revolutionize the industry that still relies on the venipuncture procedure to process blood samples and assess the health of individuals, some of whom had severe medical conditions undetected or falsely evaluated by the machine. The Edison was used for limited testing mainly for show, but it typically gave false results that compromised the health of customers.

Where Are They Now?

WeWork has survived its shaky start and reported that it's 2022 first quarter operating loss narrowed sharply as gross desk sales reached prepandemic levels with the gradual return of employees in the U.S. to in-person work. The company now rents out trendy shared and private office space. Recently, it reported that revenue rose 28% from a year ago, with 166,000 desks sold, the highest level since the first quarter of 2020. WeWork went public in October 2021 through a merger with a special-purpose acquisition company (SPAC). 

Theranos was not so lucky. The company dissolved with the approval of the board of directors and shareholders. It owed $60 million to unsecured creditors. As part of the dissolution, it turned over its assets and intellectual property to credit and investment firm Fortress Investment Group that currently manages $53.3 billion of assets on behalf of over 1,900 institutional clients and private investors worldwide across a range of credit and real estate, private equity and permanent capital investment strategies. Theranos had breached a covenant governing a $65 million loan it received from Fortress. Under the loan terms, Fortress was entitled to foreclose upon the company’s assets if its cash fell beneath a certain threshold.

The management by Fortress helped to bring about the resolution of the matter. It enabled Theranos to pay off Fortress and left $5 million to distribute to its unsecured creditors. Theranos also agreed to pay $4.65 million as part of a fraud settlement brought by more than 175,000 consumers in Arizona, where its first wellness center was set up in Walgreens. It also paid a $30,000 civil penalty as part of the federal settlement with CMS.

A Cautionary Tale for Silicon Valley

These stories are a cautionary tale for Silicon Valley. In both cases, ethics was disregarded for the pursuit of self-interest. Investors were eager to find the next billionaire start-up company and get in on the ground floor. Each company had an “angel investor” who funded the company from the beginning, bought into the hype, and was reluctant to admit the failures even after it was obvious to members of the board of directors.

American author and philosopher Aldo Leopold once said, “Ethical behavior is doing the right thing when no one else is watching—even when doing the wrong thing is legal.” It was legal to hype the company until outside investors and customers came into the picture and fraudulent numbers and promises were made to entice them to invest.

In short, ethics is sometimes easier said than done, especially when an engaging CEO is blinded-by their own dream to the detriment of others and employee-like worshippers have drunk the Kool-Aid.

Blog posted by Dr. Steven Mintz, The Ethics Sage, on May 16, 2022. You can sign up for Steve’s newsletter and learn more about his activities on his website  (https://www.stevenmintzethics.com/) and by following him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.

Steve has written a book on being a more ethical person, Beyond Happiness and Meaning: Transforming Your Life Through Ethical Behavior. It is available at Amazon or on his website.