Ready, Fire, Aim: A Standoff in Silicon Valley and What It Means For Innovation, Investment, and Regulation Moving Forward

Executive Summary

The increase in funding by venture capitalists (VCs) in the start-up space has fuelled more competition between start-up firms. This has resulted in the lack of transparency and regulation, which has promoted fraud and deception in Silicon Valley. While examples like the downfall of WeWork and Theranos are outliers, a lack of transparency will hurt future investors and the credibility of Silicon Valley if the culture of constantly pushing innovation boundaries continues to accompany the influx of unregulated funding. Transparency among investors and board members needs to be instilled by an external regulator body to promote a healthier investment space. More importantly, the culture of Silicon Valley must change from the inside in terms of how investments and due diligence are conducted. Through regulatory policing by quarterly public reports to investors as well as policymakers holding current founders and board members accountable, the standard for future investors will be raised.

Introduction

Although she usually wears a black turtleneck, Elizabeth Holmes dressed in a grey blazer for her first appearance in court. Outside the San Jose courthouse, dozens of reporters, locals and fans gathered on the morning of August 31st to catch a glimpse of the now disgraced Theranos founder. Facing 12 charges of fraud over her role at the now defunct blood testing start-up, Holmes was accused of deceiving investors and patients of her company’s ability to diagnose over 200 blood tests with just a few drops of a patient’s blood (Griffith, 2021).

So how did someone who was once compared to Steve Jobs — for both her outfit choices and her ambition — lose grip of a company that was once valued at $9 billion? This remains unanswered, and the Theranos trial poses an even bigger question: Who is to blame? The ambitious founder, the excited investor, or the laissez-faire government?

In order to answer this question, we have to go back to how we got here. Commonly known today as the global centre for technology and innovation, Silicon Valley first took shape as the epicentre we know in the 1960s (Wiener, 2021). Lured by the booming technology and defence industries in the area, thousands of men and women poured into the Santa Clara valley each year. The Digital Age (internet, etc.) followed, which led to the rise of the many global tech champions like Apple and Facebook. Since then, Silicon Valley has transformed into a global beacon of innovation and opportunity. Icons such as Mark Zuckerberg, Larry Page, Travis Kalanick and Elon Musk are among the many who call Silicon Valley home. Many of the companies these icons founded are woven into our daily lives and play critical roles in how we live and interact with the rest of society today. While the spotlight and glory have been put on them, their successes would not have been possible without investors who believed in them when their ambitions were merely dreams. The dominant rise of these start-ups inspired generations of future entrepreneurs to head to Silicon Valley. This led to newfound sources of investment — all with the hopes of seeing a healthy return — which has supercharged the pace and expectations of these new ventures (Kenney, 2018). Today, Silicon Valley isn’t just a location, it’s a way of thinking. Phrases like “Move fast and break things,” “Fail early, fail fast, fail often,” and “Build it and they will come” have cultivated the notion of disruptive innovation. While it has brought about ground breaking technologies and products, it has also raised important issues. Should Silicon Valley be responsible for the cost of innovation, especially to those people harmed by their various failures? In other words, what role specifically does the government play in regulating this innovation? As our society becomes increasingly more reliant on technology, the government is trying to keep up with the fast rate of change that exists in Silicon Valley.

Flash forward to today. The Theranos trial doesn’t just have Elizabeth Holmes’ fate in its hands. Founders, investors, and policy makers alike are all stakeholders here. The outcome will hopefully give some clarity for who is to blame — the founder, the investor, the government, or all of the above. With this, we can begin to ask: What will, what should, and what must change moving forward?

Problem

How did Elizabeth Holmes mislead so many A-list investors and board members? The “fake it till you make it” culture, where founders are encouraged to dream big and accept failure, has created an environment that penetrates the deeper culture of Silicon Valley. With an influx of investment from various sources such as private equity funds, angel investors and venture capitalists since the 2000s dot-com crash, the lack of government regulation and the “dreamist” culture promoted in Silicon Valley has been called to question.

Problem with Founder Culture:

The dreamist culture started with Thomas Edison, the founder of over 100 inventions. From the incandescent light bulb to the first movie camera, Edison is a legend that percolates through the streets of the Bay Area. Many believe he embodied the term “fake it until you make it.” Edison claimed to have invented the incandescent lightbulb long before he had actually gotten it to work. He deceived investors by faking demonstrations to buy himself more time and money before eventually succeeding (Duhigg, 2020).

Edison’s story captures the very essence of what entrepreneurship means. Most jump off a cliff and figure out how to build the plane on the way down. Whether it was Steve Jobs or Jeff Bezos, in the initial stages of their ventures, they all sold a dream of what could be without necessarily having a clear path of how to get there. Today, the success stories in Silicon Valley promote a flood of entrepreneurs all giving their best shot of making it big and potentially changing the world with their idea. The availability of low-cost infrastructure and open-source software decreased entry cost into building a start-up dramatically, while increasing the speed of establishing new digital businesses. However, low barriers-to-entry do not guarantee success (Kenney, 2018). In fact, it does the opposite. With more firms competing for the same slice of the pie, fewer companies survive today, with only 10% of start-ups surviving past the first year (Mcnamee, 2020). The increase in founders has led to increased secrecy among companies internally — including within their departments, board members and investors. In efforts to “win the race” and maintain a competitive edge, a worrisome amount of disconnect and lack of transparency both publicly and privately has painted a fine line between ambition and misguidance.

When Steve Jobs first sold the world on a device that had cellular ability, an iPod and internet access all in one, the prototypes shown in the demonstration were far from the complete product we all know today as the iPhone. Instead, he used separate devices to show each of the functions of the iPhone while engineers scrambled to complete the final touches that incorporated all the functions of the iPhone into one device (Sun, 2019). Many “geniuses” of the past teetered along this line. Some of it might have been luck (and some skill), but one thing they all share is the idea of building something for the “near-future,” — not for now, but for tomorrow — even when tomorrow’s technology is not available yet. This poses a risk that many entrepreneurs have to take on. It is an admirable thing to do, but in the hands of the wrong person, the pressure could skew them more towards insanity and desperation.

Problem with Investors:

In efforts to ride the wave of technology and the disruptive nature Silicon Valley has created, both private and public investment firms pumped exorbitant amounts of money into companies to keep them private and avoid entering the public markets to raise funding. Traditionally, private funding in Silicon Valley was limited. After a company’s incubation stage, many would have to raise capital from public investors by listing on a public exchange. This model promoted companies that were the most efficient and capable (Kenney, 2018). Quarterly reporting of financials and investor calls kept public investors informed and the company in check. Any sign of bad market news or undesirable finances would cause investors to pull their money, causing the company’s stock price to drop. Post dot-com crash, the finance euphoria concentrated around funding platforms and making exorbitant returns by investing early has fuelled the search for the next global champion firms. This sparked an increase in fund size and investments venture capitalists were willing to make, which allowed for the exponential growth Silicon Valley has seen in the last 20 years.

The increasing amount of investment adds pressure to firms to make use of all available capital. The increase in the number of firms in the start-up space promotes a new model of rapid growth and expansion at all costs (Duhigg, 2020). Capturing a large portion of the market as quickly as possible in hopes to squeeze out any competitors is becoming the new model of disruption. The generally accepted notion that large amounts of capital are needed in the initial stages of start-ups to allow younger firms to outpace their competition has created a culture where investors are increasingly comfortable with absorbing the exceptional losses of the business. Firms like Uber and Spotify continued to lose money and remain private for far longer in order to undercut incumbents, begging the question: At what point do the risks venture capitalists take on these investments become a matter of probability versus a systematic issue? Furthermore, start-ups sustain losses for such long periods of time, so it’s practically impossible to question the economic and social benefit to society until a much later stage.

From a founder’s perspective, private funding is desirable. The lack of a regulatory surveillance means founders can be more secretive in monopolizing the sector, in efforts to gain a competitive advantage (Kenney, 2018).. On one hand, private funding allows start-ups the freedom of flexibility and the ability to capture more market share faster and enables start-ups to hide operation metrics and financials from public view. Such opacity has fuelled their ability to commit fraud, deceive the public — and in the case of Theranos, even their own private investors and board members.

For decades, venture capitalists succeeded in defining themselves as judicious meritocracies who direct money to those that use it best. However, in light of the WeWork and Theranos scandals, it is hard to believe that venture capitalists can still balance greedy impulses with enlightened innovation without official checks and balances. Venture capitalists today seem less interested in the public good as they are in optimizing their own profits. Lack of managerial oversight makes investments look more like trading floor bets rather than well informed decisions. In many ways, venture capitalists are starting to embody the cynical nature of modern capitalism. They are shifting to reward the crafty, deceptive middlemen rather than the hard-working employees and creative businesspeople.

Elizabeth Holmes pleaded not guilty to all 12 charges of fraud (Griffith, 2021). There is an argument to be made that you cannot blame Elizabeth Homes for being Elizabeth Holmes. It was clear to everyone around her that she had been selling an idea that was too good to be true. Instead, many have pointed the finger at the people that empowered her and brought into her dream without carrying out the right due diligence, an increasingly common dynamic within Silicon Valley.

Problem with the Government:

With the rapid rise of big tech firms and the popularization of start-up culture, government driven regulatory action faces an uphill battle. From Facebook’s Cambridge Analytica Scandal to Apple’s Siri privacy lawsuit to the Theranos trial, big tech companies need to be more accountable for how they deal with data, funding, and their consumers (Kang, 2021). A pattern developed in Silicon Valley where the lack of government policing leads to mistrusted legislators and a public who are increasingly questioning the monopolistic power some tech companies hold (Criddle, 2020).

In the past, politicians were usually reluctant to criticize Silicon Valley and the role venture capitalists played in these start-ups as being crucial to innovation. The repercussions of Obama’s love for Silicon Valley and Trump’s craving for their approval have led regulators to be completely defanged in doing real investigations into any unethical behaviour of venture capitalist firms and start-ups. With little evidence of any progress from a regulatory side with constant tech scandals such as accusations of data privacy, the spread of misinformation and incompetent handling of funds and investor expectations, government regulators missed the window of opportunity to regulate big technology companies in Silicon Valley while they were in their infancy. A waterfall effect has carried through into start-ups and smaller firms such as WeWork, where not one board member has spoken openly or have been held accountable for the collapse of the firm.

With these lawsuits, the current state of the U.S. government finds itself in a predicament. How can they regulate Silicon Valley while maintaining its entrepreneurial culture? Is it too late to implement a cultural change in Silicon Valley?

Recommendations

Regulation needs to come from the government, but it remains to be seen whether they can act quickly enough and take more of an active and assertive approach in regulating Silicon Valley. The challenge is maintaining the entrepreneurial culture while integrating it with principles that can be regulated both internally and externally. The necessary cultural change overseen by an external regulator body would allow private companies to still move fast, but not faster than the speed of thought with guardrails in place to prevent fraud or deception.

1.Investing in products as much as the people:

Silicon Valley has a long standing notion of investing in the people rather than the products. In the past, many investors placed bets on the minds behind the products. Recent cases of WeWork and Theranos beg the question of whether a realignment of the amount of investment and trust placed on the person is necessary. The strict regulatory framework a product needs to pass before they go to market today sets a fast and efficient way to monitor the development of a product and give investors more confidence. By leveraging on this infrastructure and putting more stringent regulations on products in each of their prototype stages, it would be much easier to regulate and judge the success of a company or product well before it goes public.

2.Quarterly reporting similar to public companies:

Enforcing a quarterly reporting system that is audited by a government agency such as the SEC would allow private companies to update their investors and the regulatory agencies on operational and financial progress. While secrecy and the privatization of this sort of information is in the DNA of Silicon Valley start-ups and paramount to gaining a competitive edge, the regulations of reporting should still be made and reported. However, in this case, it would not be released to the public. By having a private, systematic way of reporting financials, it allows for transparency within the parties involved without giving away the company’s “secret sauce” to competitors and the public.

3.Accountability for all parties involved:

The lack of accountability among investors allowed board members and investors to shy away from the spotlight scot free. Until we see a venture capitalist prosecuted for failing to uphold their duty as an investor or board member, no significant change will come about (Smith, 2019). There should be a legal duty attached to investors and board members. When prosecuted and held accountable, the chances of Silicon Valley transforming will be much more likely. It is the government’s duty to take more of an active, assertive and holistic approach to attack the problem. By holding each party accountable, it will spark a cultural change from within on how investors approach and manage investments.

Alternatively, isolation from all three parities by bringing in a non-government affiliated regulatory body that is not fiscally attached or invested into Silicon Valley (independent of investors, founders and the government) could be the solution. The government, investors and founders to some extent all have skin in the game and accountability from an external body could ensure no suspicious activities in efforts to omit selfish motives and any inclination towards secrecy. Upholding the values and practices they claim to abide by will be vital in any progress towards accountability and ultimately the financial safety of investors as well as protection towards the public from unsatisfactory products.

Conclusion

A shift in culture and regulation is necessary to move past the suspicious state of funding and operations of many Silicon Valley firms. Ironically, Silicon Valley is the very place to look for new ways of doing things better. As important as it is to maintain checks and balances in the nature of how start-ups are run and funded, the government must be careful not to disrupt the DNA of what makes Silicon Valley special. Instead, they should provide a framework with room for founders and investors to work within. The need to maintain the entrepreneurial culture and spirit of Silicon Valley while integrating it with principles that can be accounted for both internally and externally will be the government’s greatest challenge in the years to come. But while the government looks towards feasible restrictions and regulations, the consequences of the Theranos and WeWork scandals will continue to transform the culture of Silicon Valley internally. This might have been the wakeup call all three parties needed. Just how big of an awakening is yet to be seen.

References

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Duhigg, Charles. “How Venture Capitalists Are Deforming Capitalism.” The New Yorker, 23 Nov. 2020, https://www.newyorker.com/magazine/2020/11/30/how-venture-capitalists-are-deformingcapitalism.

Griffith, Erin. “The US vs Elizabeth Holmes.” The Daily, season 1, episode 22, New York Times, 16 Sept.2021.

Kang, Cecilla. “Facebook vs the White House.” The Daily, season 1, episode 31, New York Times, 20 July2021.

Kenney, Martin, and John Zysman. “Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance.” UC Davis, Routledge Taylor & Francis Group, 2018, https://kenney.faculty.ucdavis.edu/wpcontent/uploads/sites/332/2018/11/Unicorns-Chesire-cats-and-new-dilemmas-of-entrepreneurialfinance-1.pdf.

Mcnamee, Roger. “Big Tech Needs to Be Regulated. Here Are 4 Ways to Curb Disinformation and Protect Our Privacy.” Time Magazine , 29 July 2020, https://time.com/5872868/big-tech-regulated-here-is-4- ways/.

Smith, Brad. “Tech Firms Need More Regulation.” The Atlantic, 9 Sept. 2019, https://www.theatlantic.com/ideas/archive/2019/09/please-regulate-us/597613/.

Su, Jeb. “Confirmed: Apple Caught In Siri Privacy Scandal, Let Contractors Listen To Private Voice Recordings.”Forbes, 30 July 2019, https://www.forbes.com/sites/jeanbaptiste/2019/07/30/confirmedapplecaught- in-siri-privacy-scandal-let-contractors-listen-to-private-voicerecordings/? sh=6f1cea227314.

Wiener, Anna. “Does Tech Need a New Narrative.” The New Yorker, 15 June 2021,https://www.newyorker.com/news/letter-from-silicon-valley/does-tech-need-a-new-narrative.