A Due Diligence Checklist for Tech Investors Lessons from the Theranos Scandal

Could a $9 billion unicorn really be built on hollow promises and faked demonstrations? The collapse of the blood-testing startup provides a masterclass in the failure of investor due diligence, which is the systematic process of verifying a company’s financial, legal, and technical claims before committing capital. Investors who lost hundreds of millions ignored glaring red flags because they were mesmerized by a compelling founder and an elite board of directors.

John Carreyrou’s Bad Blood details how Elizabeth Holmes and Sunny Balwani deceived the business world for years. Due diligence is the rigorous investigation of a potential investment to ensure all facts are accurate. In Silicon Valley, this often involves "technical due diligence," where independent experts audit the product to confirm it actually functions as described.

Theranos claimed its "Edison" device could perform hundreds of tests from a single finger-prick of blood. Most investors accepted these claims as truth without demanding proof of third-party scientific validation. This lack of scrutiny allowed a culture of fraud to flourish behind a curtain of extreme corporate secrecy.

Validate Claims Beyond the Founder’s Hype in Investor Due Diligence

Many Theranos backers relied on "social proof" instead of independent verification. They saw luminaries like George Shultz and Henry Kissinger on the board and assumed these experts had already vetted the technology. Real diligence requires looking past a founder's charisma to examine raw data and experimental results.

One striking data point from the book shows that Theranos claimed to have been validated by ten of the fifteen largest pharmaceutical companies. In reality, giants like Pfizer had walked away years earlier after finding the technology unreliable. Investors should have demanded direct contact with these supposed partners to confirm the startup's claims.

Audit the Financial Operations of Venture Capital Targets

Theranos operated without a Chief Financial Officer for nearly a decade after Elizabeth Holmes fired Henry Mosley in 2006. In the world of venture capital, the absence of an independent financial lead is a massive red flag. It suggests that the founder wants total control over the narrative without any internal checks.

Investors like Partner Fund Management were shown projections of $1.68 billion in revenue for 2015. However, internal company documents used for stock pricing estimated revenues at just $134 million. A basic audit of the company's books would have revealed this astronomical gap between marketing materials and internal reality.

Perform Technical Teardowns for Evaluating Tech Startups

Retailers like Walgreens and Safeway invested millions in "wellness centers" before ever seeing the inside of the "black box." They accepted a two-page letter from Johns Hopkins as a scientific endorsement. That letter was merely a summary of a meeting and expressly stated it was not a product endorsement.

When evaluating tech startups, investors must insist on "blind testing." This involves sending known samples through the startup's device and comparing the results to established laboratory standards. Theranos avoided this by claiming their technology was a "trade secret," a common tactic used to detecting fraud early by those who know what to look for.

Stories of Missed Red Flags

The Walgreens deal is a perfect example of how the fear of missing out, or FOMO, can override sound judgment. Dr. J and Wade Miquelon were so eager to beat their rival, CVS, that they ignored their own consultant’s warnings. Kevin Hunter repeatedly asked to see the lab and was denied, yet Walgreens still committed $50 million to the partnership.

Partner Fund Management also fell for the ruse by accepting scatter plots that supposedly proved the device's accuracy. These charts were actually generated using commercial Siemens machines, not Theranos's proprietary technology. Because the investors didn't verify the source of the data, they handed over $96 million for a product that didn't exist.

Three Actions to Verify Startup Health

1. Hire an independent laboratory or engineering firm to perform a technical "teardown" of the prototype in a controlled environment.

2. Require a list of all former employees from the last two years and conduct exit interviews to identify patterns of high turnover or ethical concerns.

3. Contact the regulatory agencies the company claims to be working with, such as the FDA, to confirm the status of any pending approvals or clearances.

When the Standard Process Falls Short

Critics of the venture capital model argue that the pressure to secure deals in competitive rounds makes deep due diligence difficult. In a fast-moving market, investors who ask too many questions might be cut out of the next hot unicorn. This creates an environment where secrecy is rewarded and skepticism is punished.

Some believe the Theranos board was too focused on "big picture" strategy and military applications to worry about lab operations. However, a board's primary duty is oversight. When a company hides its core technology from its own directors and investors, the risk of catastrophic failure increases exponentially.

Rigorous verification protects capital from the charismatic lure of a founder who prioritizes vision over functionality. Investors must treat extreme secrecy as a liability rather than a sign of innovation. Schedule an unannounced site visit to see the product operating in a live, non-demo environment.