Theranos, WeWork and the appropriately-named HeadSpin have all been in the headlines for misleading investors. Technopreneurs are naturally optimistic, but where are the red lines when representing your startup to investors?

The fraud trial of Elizabeth Holmes, Founder of blood-testing company, Theranos, began recently on 31 August 2021. According to allegations made by John Carreyrou in his book “Bad Blood”, Theranos’ Edison blood testing devices never worked. This did not stop Ms. Holmes from allegedly orchestrating multiple cover-ups and representing that they had a working break-through product, raising $700 million, with a peak valuation of $10 billion in 2013.

It is an extreme and shocking case littered with lies and deceit, and ending in tears.

WeWork’s implosion with its failed IPO in September 2019 created seismic waves in the startup world. Founder Adam Neumann raised more than $12.8 billion, with a peak valuation of $47 billion in January 2019, thanks to the unquestioning support of Softbank. Neumann continued to represent the flexible shared workspaces company as a tech startup and definitely not a real estate company, as described in “The Cult of We” by Eliot Brown and Maureen Farrell.

The rule of thumb should always be whether the sophisticated investor doing their own diligence can make a fair assessment of an investment opportunity, based on what is represented verbally, in pitch decks, financials or in any other way by you, the technopreneur, and your advisors.

Therefore, if Softbank wanted to believe that WeWork was a tech startup and not a real estate company based on the facts presented, then they should be sophisticated enough to make that assessment.

WeWork’s downfall came with the filing of its IPO S-1, when the broader investment and banking community got to see its financials for the first time. Although it had made a loss of $1.9 billion in the previous year, their creative “Community-Adjusted EBITDA” showing that they were in fact making a profit, was particularly amusing for this community.

Community-Adjusted EBITDA was WeWork’s net income measure not only after interest, tax, depreciation and amortisation, but  also “building-and community-level operating expenses”, the biggest single expense category for the company, which included rent, utilities, staff in the buildings etc.

Whilst this a particularly adventurous case (which backfired) it is quite common to see companies creating their own non-GAAP metrics. A review by financial data platform FactSet found that since 2016, 75% of companies in the Dow Jones Industrial Average have reported non-GAAP earnings per share that exceeded their GAAP earnings, on average.

At Corniche Growth Advisors, we see startups frequently reporting “Adjusted EBITDA” or “Normalised EBITDA”, and this is not misrepresentation, in our view, as long as it is flagged, disclosed and explained.

If a pitch deck shows the technopreneur’s most optimistic view of their 5-year rollout in the gazillion dollar market that it is about to disrupt, the sophisticated investor is expected to have its own view on that. Whilst the technopreneur’s judgement and credibility may be called into question, leading to a negative investment decision, it is unlikely that this would be see as blatant misrepresentation. Either way, you the technopreneur, are well advised to “keep it real”.

But when it comes to the historical  and current business, you have got to “keep it real’.

Which brings us onto the case of Palo Alto-based HeadSpin, which has raised $116 million over 6 years for its platform that helps companies optimise customer digital experiences across mobile and web. The SEC charged the former CEO, Manish Lachwani in August 2021 for defrauding investors out of $80 million.

There were many examples of fraud, such as creating fake invoices, altering real invoices, thus inflating HeadSpin’s ARR (Annual Recurring Revenue). However, the SEC also took exception to certain false statements in the pitch deck, such as the company had experienced “no customer loss” , falsely inflated “revenue commitment amounts and growth percentages for specific big-name customers”.

Regulated advisors such as Corniche Growth Advisors* can and should help you navigate the redlines of what is, and is not acceptable. Indeed they have a duty to the regulator to ensure that the source of all data is properly checked and referenced, and  the documentation fairly represents the investment proposition to professional investors.

Technopreneurs tend to hype the future – it’s the nature of the beast. But never misrepresent your current or historical business. Our best advice is to always “keep it real’ or your credibility may be in question, or worse, it could end in tears.

(The contents of this document are communicated by, and the property of, Corniche Growth Advisors Limited, and no liability is accepted by such persons for the accuracy or completeness of any information or opinions contained within it. This document is directed at persons who fall within the definition of ‘professional clients’ as defined in the rules of the Financial Conduct Authority (“FCA”) of the United Kingdom.)