No one likes being taken for a fool. Which is why as a society we so heavily penalize fraudulent behavior. If you intentionally lie to someone for personal gain, that’s fraud. For example if you forge documents to trick investors into thinking your company is making more money that it actually is, you’re going to prison. But what if you believed the lie? If you simply expressed your belief to an investor that you’re about to sign a high value customer, and it doesn’t happen, there’s no fraud. Prosecution of fraudulent misrepresentation requires intent: the burden of proof is on the investor to prove you were intentionally deceiving them. This distinction is made for practical reasons: anyone trying to change the world needs to believe they can do something that others think is impossible. Since 9 out of 10 startups fail, by definition most founders’ beliefs will turn out to be wrong. It only becomes fraud when they lie about what they’ve achieved so far.
Steve Jobs famously was described as having a ‘reality distortion field’. He could convince his employees at Apple to believe whatever impossible task he had at hand was possible, with a mix of charisma, charm, and persistence. We don’t call Steve Jobs a fraud, because he actually pulled it off, building one of the most valuable companies in history. Unfortunately he posthumously became the poster child for a famous fraudster, Elizabeth Holmes of Theranos. The fellow Stanford dropout idolized Jobs, hanging pictures of him on her wall, hiring the ad agency that worked on Apple’s campaigns, and wearing a black turtleneck to evoke his iconic look. “You’d have to look really hard not to see Steve Jobs in Elizabeth Holmes.” wrote Inc Magazine in October 2015. The very next year Theranos shut down its lab amid allegations of fraud, with Holmes net worth dropping from $4.5 billion to zero. She was conviced of massive fraud in 2022 alongside her co-founder and former partner Sunny Balwani, because she was found to have intentionally lied about the effectiveness of their blood testing technology.
The Theranos scandal is just one of several high profile fraud cases capturing the public imagination, popularized by Netflix and other streaming services with dramatized documentaries. The Tinder Swindler defrauded unsuspecting women into wiring him money, believing he was the son of billionaire Russian-Israeli diamond mogul, Lev Leviev, and therefore good for the money. Fyre Festival organizer Billy McFarlane duped social media influencers into flying to a bahamas for a luxe festival experience, instead finding disaster relief tents and stale cheese square sandwiches. Anna Delvey ripped off multiple luxury hotels and powerful real estate investors by confidently acting as a German heiress. There was also public outrage (though no proven fraud) at the billions of dollars lost on high-flying but unprofitable startups like WeWork, Snap and Uber. With Crypto and NFTs in a downward swing there will no doubt be allegations of fraud, and likely some successful prosecutions. However as we’ve discussed, losing money or failing as a company doesn’t constitute fraud alone. Amazon, Tesla, and Tencent were unprofitable for years, but now spin off billions of dollars in cash.
How do you spot the frauds from the financial successes? Who is going to be the next Steve Jobs vs the next Elizabeth Holmes? That’s a billion dollar question, but there is something all these fraud cases share: cargo cult behavior. The term ‘Cargo Cult’ comes from physicist Richard Feynman, referring to pacific islanders who made fake bamboo airports in the hopes that planes would land with supplies like they did during the war. “They’re doing everything right. The form is perfect. It looks exactly the way it looked before. But it doesn’t work. No airplanes land”. Whenever someone is copying the ‘memes’ they associate with success, without carrying out the activites that actually lead to success, that’s a red flag. Holmes with her black turtlenecks. The Tinder Swindler with his Instagram pictures on private jets. Billy McFarlane with the models he paid to do photoshoots on the island as if they’d attend the festival. Anna Delvey with her aristocratic confidence and impeccable taste in fashion.
To spot a mismatch between memes and actions, you need an operator. Theranos shunned bio-tech VCs who would ask for due dilligence, instead raising money from media moguls and former heads of state. The Tinder Swindler knew no other wealthy people, which is unusual for the son of a billionaire. Anna Delvey blamed her bank being in europe for why her credit cards were frequently declined, playing on misconceptions Americans have about foreign institutions. In each one of these cases, the fraudster avoided contact with anyone who actually was of the persona they were playing. When someone is pretending to be something that you actually are, you can tell something doesn’t add up. So if you suspect someone is playing a game, introduce them to someone their character is based on, and watch them squirm.
16 Of The Biggest Alleged Startup Frauds Of All Time
Cargo Cult Science
Civil Fraud: Fraudulent Misrepresentation in contract law (in business)
Elizabeth Holmes wrote personal notes to herself about ‘becoming Steve Jobs’ as Theranos collapse began
Everything you need to know about the Theranos scandal
How Anna Delvey Tricked New York's Party People
How Playing the Long Game Made Elizabeth Holmes a Billionaire
Misrepresentation in Contract Law: negligent, innocent and fraudulent statements (and the remedies)
Negative ROMI: Lose money to make money
Reality distortion field
Startup Failure Rate: How Many Startups Fail and Why?