When the Dream Becomes a Mirage: High-tech’s Fuzzy Math

The industry’s wizards likes to tell a good story, but sometimes they exaggerate to the point of criminality.

An example of the company Magic Leap's augmented reality.
Magic Leap

The high-tech industry is one of dreams and dreamers. The big tech companies whose products are an inseparable part of our lives began as the dream of an entrepreneur who turned an idea into reality and often transcended enormous technological barriers. To do this, these gurus needed support from investors who were persuaded to have faith in their vision. But when does an entrepreneurial dream become a mirage?

In a number of cases over the past year, entrepreneurs went a step too far. As a result, something is changing in the world’s high-tech community, which has begun to shed its innocence and ask more questions. It’s trying to better distinguish between a legitimate story and a dangerous lie between developers who dream big and fall short, and deliberate fraud.

This is a positive trend that will make companies and investors more careful about the messages they spread, whether in the press, on social media or elsewhere. It’s part of the industry’s maturing process.

In Israel, too, disgust has been growing about boasts on social media that have little to back them up. Privately, entrepreneurs, investors and others in the industry say the numbers reported in the press on the size of exits, funding rounds and other metrics are sometimes exaggerated; the discrepancy can be up 30%.

The high-tech industry is largely populated by private companies that aren’t subject to the same reporting requirements as companies listed on a stock exchange. Journalists often have no way to verify the numbers, so the truth becomes an elusive commodity. Many of the people involved have an interest to keep the real numbers to themselves and thus keep on burnishing the industry’s image.

Two incidents from the past year, one in Israel and one abroad, illustrate how the world has become more skeptical.

In late September, the Israeli press reported on a planned initial public offering by the high-tech holding group Shellanoo, which had previously raised $25 million from big-name investors like Roman Abramovich and pop star Nicki Minaj. With the IPO which eventually was canceled the company hoped to raise another 200 million shekels ($54 million), based on a 700-million-shekel valuation by consulting firm BDO.

Shellanoo, founded and run by Oded Kobo, forecast revenue of $20 million for 2017 – from an app it hadn’t yet finished developing. Besides the high valuation it sought, several other warning signs could be found in the prospectus it sent to the Israel Securities Authority.

On the day the document was released, the company had no revenues. Shellanoo explained that its valuation had been derived from a comparison to successful apps like Waze and Viber, and highlighted the number of times its app was being downloaded when the truer indicator was the number of active users.

After massive criticism in the media and around the industry of the IPO’s high valuation, Shellanoo issued a statement that essentially blamed the media for the IPO’s cancellation, not the sketchy numbers.

Theranos founder Elizabeth Holmes on the cover of Fortune.
Fortune

With the required prospectus, Shellanoo distinguished itself from other Israeli startups that reported funding rounds of tens of millions of dollars without proof of significant revenue or user numbers. These other companies raised financing from venture capital investors and didn’t have to release details on the investment, revenues or other metrics.

Theranos’ bloody example

So yes, the rules of the game change when companies want to be listed on the stock exchange and sell shares to the public there’s more transparency on reality, not just the desired valuation. In an IPO, a company has a special responsibility toward the public.

Another example the tale would make a good Hollywood movie is the American company Theranos. The company announced that it had developed a simple blood test that could be done at home, based on a simple finger prick. It would be a substitute for having to send the sample to a laboratory.

The company’s valuation reached an astronomical $9 billion. Theranos’ founder Elizabeth Holmes has graced more than a few covers of financial magazines. She was estimated to have a net worth of $1 billion, and the company also enticed a number of luminaries like Henry Kissinger to sit on its board.

But questions were asked about the accuracy of the company’s blood tests and the approvals it received; as a result, Theranos’ partners pulled out and the U.S. authorities banned the use of its unapproved devices. The company’s laboratories have been shut down, and Holmes and Theranos face investigations and lawsuits amid allegations like consumer fraud.

Theranos’ valuation was wiped out and Forbes now puts Holmes’ personal holdings at zero. Still, the company, which laid off 41% of its employees in January after 340 left the company in October when its labs closed, is still working on a new diagnostic product. But it will now have a much harder time convincing the market that it has invented something revolutionary.

Magic Leap falters

These two stories made lots of headlines, but they’re not the only ones. Questions are also being asked about augmented reality company Magic Leap, founded by former Israeli Rony Abovitz. Magic Leap raised $1.4 billion on a $4.5 billion valuation from China’s Alibaba Group and major Silicon Valley companies like Google. For years now, Magic Leap has been making headlines for the ambitious product it says it’s developing, but few outside the company have seen any of the technology.

Recent reports in the financial press say that despite the huge capital investments, Magic Leap is far from ready to unveil a prototype. The website The Information reported in December that the company’s technology was years behind what had been described.

Can Magic Leap keep its promise and come out with a product that will revolutionize the market, or will it join the list of companies that debuted with great fanfare only to disappear? Venture capital fund Andreessen Horowitz, which is investing in the company, is rebuffing the criticism; one partner has posted a picture showing a phone receiver, a bulky computer and a keyboard, noting that this was what the iPhone prototype once looked like.

Our last story comes from Israel. This month, entrepreneur Tomer Yosef, founder of the app Meetey, was questioned by the police over possible fraud and money laundering.

Yosef is suspected of raising 17 million shekels with the help of false presentations about the social app the company is developing, including the number of downloads. A criminal conviction would be an example of an entrepreneur crossing the gray line that separates optimism from unlawful exaggeration.

How did this situation come about? Mostly because no one has any real interest in changing it. The startup and venture capital world depends on continuity.

Entrepreneurs want their next financing round to exceed the previous one, and if one project doesn’t succeed, to be able to raise capital for the next one. Also, venture capital funds need to raise capital from institutions and other investors, so they want to be linked to successes. They may be tempted to inflate the value of the companies in their portfolio while counting on investors not to study the reports too closely.

Investors are keen to show off an impressive exit, and the media loves to play up big success stories. The industry doesn’t like to talk about failures, even though most startups that begin as dreams end that way too. The overall success rate is below 10 percent.

The January edition of Fortune featured a piece entitled “The Ugly Unethical Underside of Silicon Valley” that asked if entrepreneurs were taking the “fake it till you make it” approach too far. It ranked the recent scandals on a range from “everybody does it” to “time to hire more lawyers.” In the article, the founder of consulting firm StartupFactCheck says that out of 150 companies in advanced stages of development, 75 percent presented incorrect or incomplete information to investors.

This changing discussion is a positive thing. The more that people learn to ask questions and not accept claims at face value – even if these claims come from the most charismatic entrepreneur – the harder it will be to get away with gross exaggerations.

Still, the ability to tell a story is a basic part of any startup, which must obtain funding and hire workers before it has substantial activity to show for it. So caution must be exercised in the quest for the truth.

Everyone has a part to play. Entrepreneurs must be candid about their number of users, investors must cite the actual figures of exits, venture capital funds must reveal how much capital they have available for investing, and the press must ask the unpleasant questions.