Encore: Theranos | Are Venture Capitalists to Blame? | 4

Summary

American Scandal: Encore: Theranos | Are Venture Capitalists to Blame? | Episode 4

Host: Lindsay Graham
Guest: Charles Duhigg, Investigative Journalist and Pulitzer Prize-Winning Author
Release Date: October 8, 2024

---

Introduction and Context

In this riveting episode of American Scandal, host Lindsay Graham delves into the infamous rise and fall of Theranos, questioning the role of venture capitalists in the company's meteoric downfall. Charles Duhigg, a renowned investigative journalist and Pulitzer Prize winner, joins the conversation to provide an in-depth analysis of the venture capital ecosystem and its influence on high-stakes startups like Theranos.

Understanding Venture Capital

Defining Venture Capital (04:46)
Charles Duhigg begins by demystifying venture capital (VC), explaining it as an investment model where affluent individuals or groups provide capital to young companies in exchange for equity. This setup allows startups to scale rapidly without the burden of traditional debt repayment. Duhigg traces the origins of organized venture capital back to the 1940s, highlighting its pivotal role in fostering innovation and entrepreneurship.

"Venture capital is any time that a group of pretty rich people, for the most part, get together and they hand some cash to a young company and say, we're going to take a stake in your company," Duhigg explains (04:46).

Venture Capital’s Role in Tech and Silicon Valley

Historical Impact and Focus on Technology (06:48)
Duhigg elaborates on why venture capital is predominantly associated with the tech industry. He attributes this to the rapid scalability and significant returns potential inherent in technology ventures. Silicon Valley's genesis is closely tied to venture capital, with early investments in companies like Hewlett Packard laying the foundation for today's tech giants.

"Most of the VC dollars that we're aware of are going to tech. And that's because tech is the fastest growing industry. It's where the money is," Duhigg remarks (06:48).

Changes in Venture Capital Dynamics

Shift in Power Dynamics (08:42)
The conversation shifts to the evolving landscape of venture capital. Duhigg highlights a significant shift where entrepreneurs now wield more power compared to traditional VCs. With an influx of capital, VCs are more eager to invest, allowing founders greater control over their companies. This reversal has led to scenarios where entrepreneurs can dictate terms, often sidelining the rigorous oversight that VCs historically provided.

"Venture capital has made it much easier to start new companies, in part because venture capital has gone from being this small little thing to being a huge asset class with billions and billions of dollars to give away every year," Duhigg notes (08:42).

Venture Capital’s Impact on Companies like Theranos

Case Study: Theranos (12:12)
When discussing Theranos, Duhigg points out that mainstream venture capitalists largely avoided investing in the company due to insufficient due diligence. Instead, Theranos secured funding from individuals unfamiliar with the biotech sector, such as media mogul Rupert Murdoch and Betsy DeVos, who lacked the expertise to critically assess the company's technological claims.

"Mainstream venture capitalists did not invest in Theranos... it was individuals who are not professional VCs who gave Theranos its money," Duhigg asserts (12:12).

Critiques and Responsibilities of Venture Capitalists

Accountability and Governance (24:41)
Duhigg critiques the current venture capital model, emphasizing the lack of accountability when massive investments falter. Using WeWork as an example, he illustrates how VCs sometimes continue to pour funds into struggling companies to salvage their initial investments, often at the expense of minority shareholders and the company's long-term viability.

"Venture capitalists will have put money into a company and they'll be so committed to wanting to see that payoff occur that they'll pour more and more money in," Duhigg explains (19:14).

Board Influence and Fiduciary Duty (32:39)
The discussion moves to the responsibilities of VCs on company boards. Duhigg underscores the fiduciary duty VCs hold to protect all shareholders, not just themselves. He criticizes instances where VCs prioritize their profits over the company's health, contributing to scandals like WeWork's downfall.

"If I'm on the board... I have an obligation to say no to that deal to protect the minority investors," Duhigg emphasizes (32:39).

Regulatory Considerations

Need for Enhanced Regulation (35:52)
Addressing the prevention of future scandals, Duhigg advocates for stronger enforcement of existing regulations rather than the introduction of new ones. He suggests that better oversight and accountability mechanisms could deter fraudulent activities and ensure that VCs fulfill their responsibilities diligently.

"We just need regulators that are willing to do it," Duhigg states (38:10).

Potential Impact of Regulation (38:18)
Duhigg speculates that increased criminal prosecution of negligent VCs could revolutionize the industry, making VCs more cautious and responsible. This shift, he believes, is essential for restoring trust and integrity within the venture capital landscape.

"The first time one of those guys gets arrested and it's on TV, you're going to see a huge change in Silicon Valley," Duhigg predicts (38:18).

Conclusion

In concluding the episode, Lindsay Graham and Charles Duhigg reflect on the intricate relationship between venture capitalists and startup successes and failures. While venture capital has undeniably fueled innovation and growth in the tech sector, its current practices and accountability mechanisms require reevaluation to prevent future scandals like Theranos and WeWork.

Notable Quotes:

• "Venture capital is any time that a group of pretty rich people, for the most part, get together..." — Charles Duhigg (04:46)
• "Most of the VC dollars that we're aware of are going to tech..." — Charles Duhigg (06:48)
• "Venture capital has made it much easier to start new companies..." — Charles Duhigg (08:42)
• "Mainstream venture capitalists did not invest in Theranos..." — Charles Duhigg (12:12)
• "Venture capitalists will have put money into a company and they'll be so committed..." — Charles Duhigg (19:14)
• "If I'm on the board... I have an obligation to say no to that deal..." — Charles Duhigg (32:39)
• "We just need regulators that are willing to do it." — Charles Duhigg (35:52)
• "The first time one of those guys gets arrested and it's on TV..." — Charles Duhigg (38:18)

Final Thoughts

This episode of American Scandal offers a compelling exploration of the venture capital industry's role in shaping the trajectories of ambitious startups. Through Charles Duhigg's expert insights, listeners gain a nuanced understanding of the systemic issues that can lead to monumental failures and the critical need for accountability within the venture capital ecosystem.

---

Note: This summary excludes advertisements and non-content segments to focus solely on the substantive discussions between Lindsay Graham and Charles Duhigg.

Transcript

[Lindsey Graham]

Hi, this is Lindsey Graham, host of American Scandal. Our back catalog has moved behind a paywall. Recent episodes remain free, but older ones will require a Wondery plus subscription. With Wondery, you get access to the full American Scandal Archive ad free, plus early access to new seasons and more. Join Wondery plus in the Wondery app or on Apple Podcasts. A listener note this episode originally aired in 2021. From Wondery. I'm Lindsey Graham, and this is American scandal. In the mid-2010s, Theranos grew into one of the most celebrated companies in Silicon Valley. Founded by the young entrepreneur Elizabeth Holmes, Theranos promised a revolution in medicine. The company would offer inexpensive blood tests for a variety of health conditions. These tests would only require a few drops of blood, and with their availability in stores like Walgreens, millions of Americans would gain easy access to vital information about their health. It was a grand vision, but Theranos would never make good on this promise. The Wall Street Journal published a searing expose revealing problems with the company's technology and leadership. The article would ultimately destroy Theranos and lead to criminal charges against Elizabeth Holmes. Theranos became a national sensation, exposing a dark side of Silicon Valley, where companies often abide by a fake it till you make it mentality. It's a strategy that can help court investors, but it's also led some to wonder whether the tech industry needs to fundamentally change. My guest today is Charles Duhigg, an investigative journalist and the bestselling author of the Power of Habit, which explores how we can change our lives by changing our habits. He's also the author of Smarter, Faster, Better. As a reporter, Duhigg was part of a team that won a Pulitzer Prize in 2013 for a series that looked at the global problems with the tech industry. Before becoming a reporter, Duhigg worked in private equity. In our conversation, we'll look at how venture capitalists often work to create monopolies, even when the companies themselves might be troubled. And we'll discuss whether these powerful investors are ultimately responsible for failures at companies like Theranos. Our conversation is next. American Scandal is sponsored by Audible. I bet you heard that it takes 10,000 hours of practice to become an expert, right? Who came up with that? Malcolm Gladwell, in his book Tipping Point. It's an idea that becomes something of an axiom and brought criticism to Gladwell for oversimplifying complex social concepts. So what does he do? He writes a snarky follow up, Revenge of the Tipping Point. Overstories, Super Spreaders, and the Rise of Social Engineering. Too bad the Audible title itself isn't 10,000 hours long because there's more to imagine. When you listen as an Audible member, you choose one title a month to keep keep from their entire catalog. New members can try audible free for 30 days. Visit audible.com as or text as to 500 500American Scandal is sponsored by T Mobile 5G Home Internet. With new home Internet plus from T Mobile, you can get Internet right where you want it so you can boost your connection to places it hasn't reached before and transform your home Turn your backyard into a movie theater, turn your basement into a home office. For a limited time, get a free upgrade to T Mobile Home Internet plus while supplies last. Home Internet plus starts at just 50 bucks a month with autopay and any voice line. Check [e-mail] homeinternet and get Internet right where you want it. During congestion, customers on this plan may notice speeds lower than other customers and further reduction if using greater than 1.2 terabytes per month due to data prioritization. After $20 bill credit plus $5 per month without autopay, debit or bank account required regulatory fees included. For qualifying accounts, $35 connection charge applies. Charles Duhigg welcome to American Scandal.

[Charles Duhigg]

Thanks for having me.

[Lindsey Graham]

We've all heard about venture capitalists and how their money has helped fund the growth of tech giants like Uber, Facebook, and quite a few others. But let's start at the basics. What is venture capital and how does it work?

[Charles Duhigg]

Venture capital is any time that a group of pretty rich people, for the most part, get together and they hand some cash to a young company and say, we're going to take a stake in your company, we're going to take some of your stock and we're going to give you the money that you need to grow and to become the firm that you want to be. Now, what's interesting about venture capital is it hasn't actually been around that long. There's always been investors and companies, but as an organized activity, it really started basically back in the 1940s when a professor at Harvard Business School discovered that some of his colleagues over at MIT had this idea for a new kind of medical technology. And so he got together some of his friends and he said, look, we'll give you some money and some advice because you're all scientists and we're all smart business people. We'll give you some advice and give us a stake in the company. And if you do well, all get rich.

[Lindsey Graham]

So that's how it's Perhaps different from any other financing like debt or a loan.

[Charles Duhigg]

Exactly. So debtor alone is literally a bank saying, we're going to give you some money. You don't give us any stock in return, but you have to pay us back what we gave you, plus some interest. And debt or a loan is the safest kind of investment you can make. Right? If that company ends up going bankrupt and they have to sell off all of their assets, the people who gave them debt, they get paid first. Now, standing behind those people who gave them debt, the bank, are the venture capitalists, the people who gave them money and said, you don't have to pay this money back, but you do have to give us some stock in your company. And that way we own a part of the company. And by the way, if your company does well, if you have lots of profits, then we also have the right to demand some of those profits.

[Lindsey Graham]

It's interesting that you say one of the earliest examples of venture capitalism was investment in a medical technology company, because this series just looked at Theranos. Why are venture capitalists so often associated with technology? Are they only designed for that kind of business?

[Charles Duhigg]

Not necessarily, but I went to Harvard Business School, and when I was at hbs, we learned the Willie Sutton rule. Willie Sutton was a great bank robber, one of the most successful bank robbers. And when eventually he got caught, a reporter came up to him and they said, willie, why do you rob banks? And Willie said, well, because that's where the money is. And that's why venture capital is investing in tech right now and for the last 20 years or so. Right? It's not that technology is something special that venture capitalists didn't invest in other things. In fact, there's lots of venture capitalists who invest in all kinds of other things and in manufacturing companies and supply chain companies. But most of the VC dollars that we're aware of are going to tech. And that's because tech is the fastest growing industry. It's where the money is. Not only that, but the thing that we know about technology, at least as the industry is constructed right now, is that you can get these economies of scale, right? You give someone a million dollars and they build Facebook, and suddenly Facebook is worth $5 billion. They don't have to hire a bunch of people. There's also some historical precedent here, which is that the birth of the tech industry, as we think about it, the birth of Silicon Valley, was rooted in venture capitalism. When Hewlett Packard started, which was one of the original tech companies that really created Silicon Valley, they were backed by a small group of venture capitalists. When Stanford decided to start really growing aggressively to become a powerhouse university, one of the things that they did is they really put a lot of money into venture capital in the Silicon Valley area. And the thing that they build in Silicon Valley is they build tech. And so since essentially the origins of the contemporary technology industry, venture capital has grown up alongside it, because that's where the money is.

[Lindsey Graham]

Well, it sounds like venture capitalists then have pretty much fundamentally changed the business landscape in the last 60, 80 years.

[Charles Duhigg]

What they've done is they've definitely created a new source of capital for companies. They have supercharged the ability to create new companies and start new companies. If you were to go back to the 1950s or 60s, starting a new company was a big deal. It was like you had to go find the money and you had to convince other people to join you. It was a big, big risky thing. Most people worked for IBM or they worked Hewlett Packard. It was the rebels who would go off and start firms. Nowadays, to start a company, all you really need to do is know how to put together a PowerPoint deck with four or five slides and promise that you're going to make $5 billion someday. And so you're right. Venture capital has made it much easier to start new companies, in part because venture capital has gone from being this small little thing to being a huge asset class with billions and billions of dollars to give away every year.

[Lindsey Graham]

You make it sound like it's almost free money.

[Charles Duhigg]

I mean, for some companies it is free money, right? At least at first. The problem is that there is no such thing as a free lunch or free money over the long term. And so when you work with venture capitalists, you are definitely giving something up. You're giving up equity oftentimes, you're giving up control, you're giving up the ability to determine your fate. Now that started shifting in the last couple of years, particularly among these sort of high flying entrepreneurs and who seem like they have unicorn dust on them. Traditionally, venture capitalists were in charge. They were the guys and some gals, but they're mostly guys. They were the guys with the wallets who had the cash so they could call the rules. But what's happened in the last decade in particular, as there's been so much growth, so much economic prosperity, is that so much money has flooded into venture capital that they're now desperate to give their money away. And that's empowered entrepreneurs. Entrepreneurs can now make demands of venture capitalists that they couldn't make previously. They get to pick and choose who they're going to allow to invest in their companies. And as a result, the power dynamic has shifted. Another important shift that's occurred is that venture capitalists used to be the adults in the rooms, right? So there was this one early venture capitalist named Tom Perkins, who was a famous venture capitalist who helped build 60 or 70 companies. He's one of the founders of Kleiner Perkins, which is one of the best known venture capital firms from the last wave of tech. And Perkins would go in and he would actually get really involved in these companies. He would invest in a company, he would show up at their offices one day a week, and he would hold people's feet to the fire. He would ask them, how much are you spending? Show me your budgets. Prove to me that you're making good choices. He brought what's known as good governance to firms. He was really involved in the companies that he funded. And this was true of venture capitalists throughout the 60s and 70s and 80s and 90s, venture capitalists were the adults in the room. And then this dynamic that I mentioned before, when all of a sudden there's so much more venture capital money now suddenly entrepreneurs can start calling the shots. They're in charge because they can say, I'm going to let you invest in my company. One of the demands that entrepreneurs had was to say, look, if I'm going to let you invest in my company, I don't want you sticking your nose in here. I don't want you telling me what to do. In fact, I want you to give me enough power so that I have a super voting authority on my board. You can't rein me in even if you want to. And I think many people would argue that has been a change, not for the better.

[Lindsey Graham]

Was this the issue at play with Theranos? Elizabeth Holmes managed to raise a lot of money from investors while maintaining a tight grip over her company.

[Charles Duhigg]

I don't know the Theranos story very well. I've never reported on Theranos, but just from reading the coverage, what I do know is my understanding is that Elizabeth Holmes and others went to mainstream venture capitalists and that particularly in the biotech space, right? People who know that space really well, people who know the blood technology space particularly well, and that those folks started doing their due diligence. They started asking things like, can you give me proof that your technology works? How many peer reviewed, published papers do you have about this technology where other scientists are objectively evaluating it and determining whether it lives up to its promise. And whatever those established venture capitalists heard, it made them decide not to back this company. The people who backed Theranos are like Rupert Murdoch, who knows media really, really well, but as far as I know, doesn't know much about biotech. Betsy DeVos Betsy DeVos didn't even earn her own money. She inherited it from people who started Amway, a door to door sales company. She was the Education Secretary under Donald Trump. So I don't think that she has a degree in biotech. Maybe she's an expert in biotech, but as far as I know, she isn't. So my guess is that those people were just in a position where they really weren't qualified to do due diligence. And they didn't reach out to ask people who knew how to do due diligence on biotech to evaluate this investment before they handed over their money.

[Lindsey Graham]

American Scandal is sponsored by Uncommon Goods Spark something uncommon this holiday with just the right gift from Uncommon Goods. Incredible hand picked gifts for everyone on your list. Gifts that spark joy, wonder, delight. And that. It's exactly what I wanted feeling all in one spot. Like what my wife found recently. She loves puzzles and she adores Advent calendars. So Uncommon Goods Jigsaw puzzle Advent calendars. Well that's two great tastes that taste great together. And when we shop at Uncommon Goods, we're supporting artists, independent businesses. Many of their handcrafted products are made in small batches, so better shop now before they sell out this holiday season. And with every purchase made at Uncommon Goods, they give back $1 to a nonprofit partner of your choice. So far, they've donated more than $3 million and that's uncommon good. To get 15% off your next gift, go to UncommonGoods.com as that's UncommonGoods.com as for 15% off, don't miss out on this limited time offer. Uncommon Goods. They're all out of the ordinary. American Scandal is sponsored by Aura Frames. Now here's something that I know is true. The people we love most are the most hard to shop for. Luckily, there's one gift that probably everyone on your list is sure to enjoy. An Aura Digital picture frame named number one by Wirecutter. Because Aura Frames makes it incredibly easy to share unlimited photos and videos directly from your phone to the frame, no matter where it is. So when you give an Aura Frame as a gift, you can personalize and preload it with a thoughtful message and photos using the Aura app, making it an ideal present for long distance loved ones like grandma or that aunt whose birthday you forget but who always remembers yours. It's a gift so special that they'll use it every day. And Aura Frames come in a variety of styles and colors, so you can be sure to match the taste of anyone in your life. And trust me, it's the easiest way to share. Back to school photos, cute Halloween costume photos, that video you took over the holiday. Anything that you think your friends and family might smile at can be sent to their Aura frames almost instantly. And for a limited time, visit aura frames.com and get $45 off Aura's bestselling Carver Matte frames by using promo code as at checkout. That's Aura frames.com promo code as this exclusive black Friday Cyber Monday deal is their best of the year, so don't miss out. Terms and conditions applied. Let's investigate perhaps the reason why there's so much money coming into venture capitalism. Because it should still be an industry of some fundamentals, and that is a return on investment.

[Charles Duhigg]

Absolutely. Absolutely. So the reason why so much money has come in is that during various periods, venture capital has provided huge returns. The venture capital model is kind of a strange one, because if I'm starting a venture capital firm, I know that I'm going to make, let's say, 20 investments. And I believe going in before I've even hung up my shingle, I believe that 18 of those investments are going to go belly up. They're going to declare bankruptcy. They're going to fail. Something's going to happen. They're going to be bad investments. But one or two of them, one or two of them is going to be successes. And they're not just going to be successes. They are going to be monster successes. I'm going to put in $2 million, and 10 years later or seven years later, my $2 million is going worth a billion dollars. And so it's going to make up for all the losses and all the other investments that I made that didn't work out. And for a long time, that logic was a pretty good logic because it worked again and again and again, right? You put a couple of million dollars into Facebook and Facebook becomes the biggest thing on earth. A guy named Masasan who runs a big venture capital fund called the Vision Fund, he makes a series of investments during the first tech boom, most of which are terrible, most of which go bankrupt when the economy turns. But he put a couple of million dollars into a firm named Alibaba, and those couple of million dollars end up being worth Something like 30 or 40 billion dollars by the time Alibaba becomes a giant. And so that has been the logic for a long time is I'm going to make a bunch of bets. Most of them aren't going to work out, but some of them are. And when they do, they're going to knock it out of the park. And so as a result, a lot of people standing on the sidelines, pension funds, endowment funds, particularly people who listen to a guy named David Swanson, who the endowment fund at Yale, who was very, very enthusiastic about alternative investments, about private equity and venture capital as a category of private equity, they said, look, I'm going to start reallocating my money out of stocks because the problem with stocks is it's hard to get an outsized return. I'm definitely not going to be putting it into bonds because interest rates have been low now for over a decade. I'm going to put it into venture capital because venture capital seems to be giving me higher returns. The problem with every asset class, though, is that when capital starts flooding in, usually returns go down. And that's what's happened with vc.

[Lindsey Graham]

It sounds like if when you're chasing the home run like venture capitalists do, there's a lot of incentive to not miss. So you might find yourself in some sort of gambler's fallacy, thinking that in pouring good money after bad, what's the danger there?

[Charles Duhigg]

Well, exactly as you said, one thing that can happen is that venture capitalists will have put money into a company and they'll be so committed to wanting to see that payoff occur that they'll pour more and more money in. But the other thing that's happened is that there has been this theory that has emerged known as blitzscaling, primarily within the tech industry. And it has its roots in some very sound logic. I was talking to one venture capitalist and he was talking about Uber, and he said, we were early investors in Uber, and as soon as it became clear that Uber was going to be success, there were 15 Uber competitors. And so the only way that we could protect our investment in Uber was to get Uber as big as possible, as fast as possible. And the only way to do that was to pour hundreds of millions of dollars into it so it could scale at a breakneck pace. That's blitzscaling. And it's true. One of the things about the Internet economy and the economy today is that it is this winner take all economy. There's only one Amazon, there's only one Uber. Lyft is a Little bit of a competitor. But even in that case, they're smaller and there's only two of them. And so this blitz scaling to get as big as fast as possible requires huge amounts of infusion of capital. And that's what the venture capitalists support is there's no way that a company can earn enough money to grow that quickly. They need to go to outside investors, and venture capitalists are on board. So If I've invested $5 million in this firm, and it says, we want to become the biggest firm on earth, and we need another 500 million to do that, then as a venture capitalist, it makes sense to me to give them 500 million. Not only that, but if I'm a venture capitalist, I just raised a billion dollar fund or a $1.5 billion fund, I got to put that money to work, because I don't get paid until I put that money out the door. So when one of my investments comes to me and says, we need $500 million more, even though you only gave us 5 million last time, I'm not unhappy to hear that suggestion, because I got 500 million burning a hole in my pocket. And if I can invest it in one company instead of trying to invest it in 10 companies, that means less work for me.

[Lindsey Graham]

Blitzscaling sounds like an attractive strategy. If you're certain your company is a winner, it makes an instant monopoly in the market niche that this company is operating in. But what if the company you're investing in isn't a winner? What happens when it's a bad venture?

[Charles Duhigg]

Yeah, I've never met an entrepreneur who tells me that their company isn't a winner, Right? If you're the kind of guy who says, the kind of gal who says, hey, you know what? I started this company, and I don't know, maybe it'll work, maybe it won't. You're not doing well in Silicon Valley. You're not even in the office of a venture capitalist. You know, you've gone to the Y Combinator or some other place that's taught you to say, the reason I'm starting this company is because it can change the world. If we can just sell pieces of chicken faster and more efficiently, then peace will break out all over, right? That's ingredient number one, is to say that you're going to change the world. But ingredient number two is to say, and by next year, we will have 95% of the world eating our chicken. Nobody ever comes in and says, you know, this company, maybe it'll work, maybe it won't. They all pretend or maybe even believe that they're building the most successful company on the face of the planet?

[Lindsey Graham]

Well, yeah, that's the entrepreneur's pitch, and probably the venture capitalist believes it to make the initial investment. But after that initial investment has been made, and even though the venture capitalist knows that 18 out of 20 of his gambles are going to fail, what if all 20 of them do? There's got to be incentive to continue propping up what was thought to be the winner.

[Charles Duhigg]

Yes, absolutely. Absolutely. When you're deep into a company, there's this old saying, if you borrow a million dollars from the bank, the bank owns you. If you borrow $100 million from the bank, you own the bank. And that's exactly what happens, is that venture capitalists very often will make one investment and then the entrepreneur will come back and they'll ask for more money. And they say, nah, I don't think you guys have lived up to the promise. I don't think you're the winner that I thought you were. And they cut them off. And that happens a lot. And it's usually disastrous for that entrepreneur, for that company when it happens. The other alternative is that sometimes you invest $1 million, then you invest $5 million, then you invest $10 million, and they come back to you and they say, we need more money now. And you're thinking to yourself, gosh, you know, they're not really hitting their marks, right? They're not really performing the way that I thought. But I can't write down $16 million investment at this point. The only thing I can do is give them another $20 million and hope that they'll have enough cash to figure it out and become the winner that I hoped they were in the first place. This is, I mentioned before, Masasan and Vision Fund. This is what Vision Fund has done again and again and again. WeWork is one of the best examples. WeWork seemed like it was sputtering. Things were falling apart. But Mazastan and Vision Fund had invested so much money into WeWork already that the only thing they could do was give them more money in the hopes that they can turn it around and figure it out. Because otherwise he has to tell his investors, I just lost tens or hundreds of millions of dollars for you.

[Lindsey Graham]

Tell me how today's VC deals are structured. It's probably not just one person anymore. These are big firms. It's an established business.

[Charles Duhigg]

Yeah, it is a big business. But that being said, there's usually one person inside a venture capital fund. Who is responsible for a particular investment. They're the person who's leading the investment. And then what will happen after that is if it's a big investment, let's say the Charles Duhigg Venture Capital Fund is going to put some money into Company X, and Company X wants to raise $100 million. So I become the lead investor and I, Charles Duhigg, I'm the guy inside the fund who's really going to be running hurt on this. I'm in charge of it. So I'm doing all the work, I'm negotiating all the deals. I'm going to go to other venture capital funds and I'm going to say, look, look, I'm putting in $10 million. I'm going to be the lead investor. If you want to come in, I'm going to create some space for you. You can put in 5 million, or you can put in 2 million, or you can put in 8 million. I'm going to what's known as I'm going to syndicate out this round and I'm going to let other venture capitalists participate with me. Now, the reason why I would do that is because number $100 million is a pretty big risk for me to take on my own. Right. I want to spread the risk around, but also I know that if I cut you in on this deal, somewhere down the road, you're going to cut me in on one of your deals. And so that way I don't have to look for every single great deal and elbow my way into it. I'm going to get invited in by the syndicate that I belong to. And at this point, there's really just about 10 to 15 venture capital funds. There's hundreds, hundreds, maybe thousands of venture capital funds in the world, but there's only about 10 to 15 of them that do the by far majority of the deals. These are the funds that control the venture capital industry. And one of the ways that they preserve that authority is, first of all, they have a lot of money. But second of all, they tend to syndicate with each other. They work together as a pack in order to determine which companies get in and to sometimes keep up. Starts out.

[Lindsey Graham]

We've mentioned here that the pitch for any aspiring business is that they're going to change the world, that it's not just the bottom line, it's an aspiration for the betterment of humanity. That's the entrepreneur's side. But on the venture capitalist side, do they have a mission? Is it just to earn profits or is there something larger at hand.

[Charles Duhigg]

Even guys who just want to earn profits, they never just say I just want to earn profits. The greediest person on the face of the planet will still tell you that they're in it because they really wanted to be Mother Teresa. It just so happens that they became a billionair in the process. Yeah, venture capitalists, if you talk to them, they'll tell you they got into this because they love technology, they believe technology will change the world. They want to find and encourage the companies of tomorrow that are going to make the world a better place. And a lot of them are being honest and truthful. I have a lot of friends who are venture capitalists and they're really great people. They believe deeply in what they're doing. They're fascinated by new technology. They really want to help help entrepreneurs reach their potential. Now at the same time, they also don't mind getting insanely rich and the fact that they're able to buy a Gulfstream in addition to cure cancer. Hey, it's a great world.

[Lindsey Graham]

Some people might look at venture capitalism and see the potential for a troubling system. It seems like you've got this syndicate of self dealing billionaires probably more self interested than they let on to be with an overabundance of capital that they need to spend giving bright eyed bushy tailed entrepreneurs too much control. Is that a fair criticism, you think?

[Charles Duhigg]

Yeah, there's excesses, but what you just described is the recipe for a fantastic economy. The whole point of particularly American capitalism is it's supposed to be easy to start new company and it's supposed to be easy to walk away when it's not working and start and try something new. Yeah, it's bad when it gets too concentrated, right? When there's gatekeepers who start preventing good ideas from getting executed on, when people who are clearly crazy and shouldn't be running companies are given a ton of money for bad ideas. All of that is distortive. But excesses are part of capitalism. Like there's no way to design an economy that does not have excesses in it if it has free enterprise and competition, the system that we have. Because at this moment in time there is too much money, there is too little regulation. There's basically we've had what, 12, 13 years now of unchecked growth. And so there are these excesses that you can point at and say like this is going off the rails. That's all true, but the basic system itself is a great system, like asking people to take on risk, to vote with their dollars on what they think is going to win or lose. That's much better than the alternatives, which would be the government making bets on who ought to win or lose or being in a situation where there's such little capital, everyone's so risk averse that if I have a great idea, I can't get any funding for it. And that's happened in the past. That still happens right now to some groups. Right? African Americans have a much harder time raising capital and that's disastrous for the economy, it's disastrous for those communities, it's disastrous for all of us. So I don't think you can argue that the system itself is flawed. It's just that it has some excesses right now. I also want it because I know that you guys are talking about Theranos. The important thing about Theranos is mainstream venture capitalists did not invest in Theranos. It was individuals who are not professional VCs who gave Theranos its money. It was these fringe figures who were rich but weren't in the habit of making bets on companies that supported what happened to Theranos. Theranos, in many ways you can point to, is something that's proof that the VC system actually works. Because all of the establishment VCs, they all passed on Theranos.

[C]

Hey, I'm Ryan Reynolds. At Mint Mobile we like to do the opposite of what big wireless does. They charge you a lot, we charge you a little. So naturally, when they announced they'd be raising their prices due to inflation, we decided to deflate our price due to not hating you. That's right. We're cutting the price of mint unlimited from $30 a month to just $15 a month. Give it a [e-mail] Switch $45 upfront.

[Charles Duhigg]

Payment equivalent to $15 per month New customers on first three month plan only taxes and fees, extra speed slower above 40 gigabytes of details.

[D]

The holidays are all about sharing with family meals, couches, stories, Grandma's secret pecan pie recipe. And now you can also share a cart. With Instacart family cartoon carts, everyone can add what they want to one group cart from wherever they are so you don't have to go from room to room to find out who wants cranberry sauce or whether you should get mini marshmallows for the yams or collecting votes for sugar cookies versus shortbread. Just share a cart and then share the meals. In the moments, download the Instacart app and get delivery in as fast as 30 minutes. Plus enjoy free delivery on your first three orders, service fees and terms apply.

[Lindsey Graham]

You mentioned earlier that there might be a lack of regulation in the venture capital industry. What sort of regulations are there and what are the responsibilities of venture capitalists to the public and to the companies that they invest in?

[Charles Duhigg]

So probably the biggest regulation, and this isn't just for, for venture capital, this is true for essentially all kinds of private equity investments. When you're buying securities stock in a company that's not a publicly traded company, the first thing is you have to be what's known as a qualified investor, which means that you basically have to be rich. You have to earn a certain amount of money each year, you have to have a certain amount of money in savings, excluding the value of your house. So basically the government has said unless you're rich to begin with, you can't do this kind of investing. And the reason why they say that is because they say, look, if you are rich, we assume that you're financially savvy, so we're going to let you take more risks. Now for the venture capitalist, assuming that they raise all their money from qualified investors, then when a venture capitalist invests in a company, oftentimes they ask for in return a board seat. They join the board of directors and maybe they'll get one or two seats, or maybe they won't get any. But if they join the board, that's really important because when you're on the board, you're the ultimate bosses of that company. The board can hire and fire the CEO. In most cases, the board is where the buck stops. Now there are some rules about what responsibilities you have. If you serve on a board. The biggest rule is that you have essentially a fiduciary interest to all the shareholders and not just yourself. So if, for instance, I'm on the board of a company and I learn about a takeover offer that would make me personally rich, but would screw all the minor investors, all the employees, all the other people who have bought small pieces of stock in this company. I have an obligation to say no to that deal to protect the minority investors who are not on the board. Because I represent the shareholders, I don't just represent myself. So one of the things that has been a criticism of venture backed companies is that venture capitalists will get on the boards of these companies and they will act in their own self interest rather than the interest of all of the shareholders. Again, WeWork is the perfect example of this. So when WeWork was blowing up, there was a deal that was put on the table that would have paid off all of the board members. That would have made all of the big venture capitalists essentially given them a return on their investment and would have screwed all of the minority shareholders, people like the employees who had stock. Now, there are some who would argue, and I think this is a very powerful and legitimate argument, that the board of directors, these venture capitalists who are on the board, they should have said no to that deal. They should have said, look, you have to give us a deal that treats everyone well. Even if it's going to cost me a little bit of money, it'll be better for everyone. Instead, the venture capitalist said, yep, we love that deal. Here's my pocket. Fill it up with cash. And for the minority investors, eh? Sucks to be you.

[Lindsey Graham]

When we contemplate the spectacular explosions of WeWork and Theranos, what would it take to prevent another failure of that scale?

[Charles Duhigg]

I don't think that WeWork and Theranos should have been regulated away. Right. I don't think that more regulations would have prevented WeWork in Theranos. I think in some respects, the system is working, but it's not working to the full extent. Look, Elizabeth Holmes created a fraud. She got people who invest in that fraud. The people who invested lost all their money, and she's on trial to go to jail. So it seems like that system is kind of working now. There were a lot of other people who were injured unfairly. There's people who got bad test results. There's people who were impacted by her fraud, and they deserve to be compensated. She deserves to be punished for that. But the system is trying to do that, right? We're always going to have frauds, and it's good that the people who invested lost all their money. They should also be publicly ashamed for doing it. In the case of WeWork, there's other victims, right? Unfair victims. The employees of WeWork. But again, many of the people who invested money lost a lot of their money. Money. Now, some venture capitalists who invested in WeWork, in fact, a number of venture capitalists who invested in WeWork still got rich off of it. They still made big profits. And I think that there should be opportunities for the minority shareholders and for others to sue. And Zeta venture capitalists, you should have been a better job of being the adult in the room. You should have been there making sure that things didn't go off the rails. That was your obligation. And I lost money because you didn't live up to your obligation. And I think that you should have to compensate me for that. I think that that's fair. And so I think that there are ways that we could strengthen civil liabilities and civil law to allow shareholders to sue. I think that regulators, government regulators, should be taking more of an interest in working harder to regulate companies where the board of directors does not seem to be living up to their responsibilities and does not seem to be doing a good job of keeping their eye on the firm. But these rules all exist. We don't need new regulations to do this. We just need regulators that are willing to do it.

[Lindsey Graham]

But what would that look like if regulators are doing it? What would it mean for regulators and prosecutors to get tougher on venture capitalists?

[Charles Duhigg]

So there is a feeling among some of the observers of Silicon Valley that we need to see more criminal prosecutions of directors on boards for not upholding their fiduciary duty. And one person I was talking to, he said, look, look, the first time that you see a venture capitalist be put into handcuffs and put into the police car and prosecuted criminally for not being the adult in the room, for not living up to their obligation to protect minority shareholders, to stop a crazy CEO from doing crazy things, the first time one of those guys gets arrested and it's on tv, you're going to see a huge change in Silicon Valley. You're going to see a huge change across venture capitalists. And I think that's right. Right. For a long time, regulators have been toothless when it comes to regulating private investments, in particular venture capitalists. There's been this romance about venture capitalists, that they're the handmaidens of innovation. And I think at some point some regulator is going to step up and say, actually, these guys, this is where the buck stops. They didn't do their job. Let's into court. And then all of a sudden, a bunch of other people are going to start saying, I got to pay closer attention and make sure that I don't get arrested.

[Lindsey Graham]

Next, Charles Duhigg, thank you so much for speaking with me today.

[Charles Duhigg]

Thanks for having me on.

[Lindsey Graham]

That was my conversation with Charles Duhigg, a Pulitzer Prize winning journalist and the author of the Power of habit from Wonder 8. This is episode 4 of Theranos for American. In our next series, the Houston Astros shocked the baseball world by winning the 2017 World Series. Just a few years earlier, they were the worst team in the major leagues. But their miraculous rise would be forever tainted when it was revealed that some players and coaches had cheated to gain advantage. If you're enjoying American scandal, you can unlock exclusive seasons on Wondery binge new season first and listen completely ad free when you join Wondery in the Wondery app, Apple Podcasts or Spotify. And before you go, tell us about yourself by filling out a [e-mail] survey American Scandal is hosted, edited and executive produced by me, Lindsey Graham for Airship audio editing by Molly Bach music by Lindsey Graham. Our senior producer is Gabe Riven. Executive producers are Stephanie Jens, Jenny Lauer Beckman and Hernan Lopez for Wonderful.

[E]

In the dry states of the Southwest, there's a group that's been denied a basic human right in the Navajo Nation.

[Charles Duhigg]

Today, a third of our households don't.

[E]

Have running water, but that's not something they chose for themselves. Can the Navajo people reclaim their right to water and contend with the government's legacy of control and neglect?

[D]

Our water, our fuel, our water.

[E]

That's in the next season of Reclaimed, the Lifeblood of Navajo Nation. Listen now wherever you get your podcasts.