Tuesday, January 17, 2017

Consider the Lily

Once again there's a ton to write about - Brexit, Theranos, Energous, Erin Griffith's article on Ethics in Silicon Valley, and recent developments with uBeam, but a combination of work plus, hunting for a house, buying a house, getting contractors in, and moving, are eating up all my time. Hopefully next month things will be a little more settled and I'll be back to writing more like a post a week.

In the meantime, I wanted to cover the startup story of the moment, Lily Robotics. Lily is a drone company, promising a simple to use drone (throw it in the air, that's it), that follows you and uses a superb camera to take great videos and stills without a controller - ideal for sports enthusiasts to create videos of themselves doing cool stuff. It looks fantastic, with great demo videos and a strong demand. They raised $1 million in seed funding in mid-2014, and then in mid-2015 started taking pre-orders following some amazing videos and marketing - its pre-order list reached 60,000, at over $500 each, for around $34 million in pre-sales. At the end of 2015 they then raised a further $14 million in VC (no surprises - who wouldn't invest with pre-orders like that!)

Units were supposed to ship to customers in Feb 2016, but that was delayed until summer 2016 - no surprises as hardware is hard, give the newbies a break. Then it was delayed again, this time until December 2016 (time-to-carrot of around 6 months), but once again that date came and went, until suddenly last week they simply closed down with a message to their pre-customers that they were sorry, they couldn't manage to make it, but refunds were on offer. A sad tale, a startup that bit off more than it could chew, and ultimately had to close but sought to return the money to the customers and make them right. Sad until it became public that the same day they shut down, they were sued by the San Francisco DA for misleading business practices and false advertising.

I'll leave the other details to The Register, sUAS News, and the EEV Blog, and hone in on a couple of the most interesting points in this case. Remember that one of the key parts of fundraising is to get VCs to think that there are huge numbers of customers out there for your product, and so once you have 'traction', that they want to invest (de-risked is a term used, others simply wonder why you need a VC once you have customers and profits). If you plan on 'hacking' the system to get the VC money, then you aim to get customers - but what if you have no product to sell? Then go with pre-orders! Show the customer an imaginary future product you plan to make, play up the 'plucky little startup' card, and before you know it you've got $34m in sales and VC's knocking down your door, giving you all the money and time you need to make the product and get it to your customer.

That would be the (mostly) legal way to do it, tell pre-customers it's a planned product, tell them what you are showing them is "hoped for" or "aspirational" and do your best to hit it. Or you could simply show them a faked demo and video and hope you've got time to make it a reality by the date delivery is due - 'fake it til you make it' - and this is what the SFDA is claiming Lily did. In effect, it's a variation on what it appears Theranos and others did, except faking the demos to customers, not to investors (who are still likely defrauded, if this is true).

The customers were led to believe the company had more than it did through their promotional video of the Lily in action, however all was not what it seemed. From the SFDA complaint:

Lily Robotics did not have a single Lily Camera prototype that had all of the features advertised in the Promotional Video. Instead, its co-founders Balaresque and Bradlow, who were present during the filming, brought several prototypes to use during the filming. Some, which looked good on the outside but were not fully functional, were used only for “beauty shots.” Others had some functionality but did not look like the product being advertised. Some were able to film video but even those were merely Lily Camera prototypes with GoPro-branded cameras mounted on them.

This is an important point as it highlights something I've seen happen and I think is more prevalent than most want to believe - showing mockups as working devices, claiming many features and achievements in the product, yet not revealing that not only are they not currently available simultaneously in the same product, but that they may even be mutually exclusive. The analogy would be to claim that your company's new aircraft can fly at 90,000 feet, at Mach 1, with a range of 5000 miles, carrying a 100,000 lb load and leading people to believe it can do all at the same time, when that is impossible. It can be done to investors, though they should have the resources and experience to vet such claims, so let's do it to consumers instead - they're gullible and good natured, let's fleece them! 

Of course, I'm being cruel to Lily here, founders never think like that. They're all starry-eyed idealists just looking to follow their dreams and change the world, at worst you can say they are true-believers who wanted to make it all happen, but their reach exceeded their grasp. Let's forgive them, they tried and failed, but at least they tried. 

And then you read excerpts of emails from a Lily founder talking about their demo video:

Are you sure that the GoPro lens does not create a unique deformation/pattern on the image? I am worried that a lens geek could study our images up close and detect the unique GoPro lens footprint. But I am just speculating here: I don’t know much about lenses but I think we should be extremely careful if we decide to lie publicly.

The founder was worried that smart people would find out the demo was faked, and explicitly and in writing admits that they know they are lying. It's the equivalent of being found at the murder scene, covered in blood and carrying an axe, with a signed letter about how you have to be careful if you decide to kill someone with an axe. Despite knowing it was lying and fraudulent, they decided to go ahead with it anyway. Why? Because the funding 'game' is structured to incentivize exaggeration, fabrication, and lying, and to punish honesty. Honesty doesn't get you funded, lying does. When there's millions of dollars at stake (amounts that people kill for), why wouldn't someone tell a few lies, especially when if they succeed, no-one will ever know? And that part is critical - they didn't think they'd get caught, and why would they? How many startup founders have you heard of going to jail for this kind of thing?

A further question that springs to mind is why the VC firm that invested after the pre-sales didn't spot this during their due diligence. Surely they learned that the promo video didn't match what was shown? If they didn't, they were either lied to and also defrauded, or it smacks of incompetence if they missed it. If they did find it, then it's even worse, because they're then complicit in the deception. Faced with being labelled incompetent, fraudsters, or themselves defrauded, I wonder how long before the VC in question joins in the complaint against Lily and sues.

Which then brings the next question - who gets paid back first? Normally in liquidation the VCs get pain off first (preferred stock), but if there is debt then that has to be paid first. In suing to get back their $15m the VCs will have to wait behind the customers' $34m of refunds (who themselves are behind a $4m bank loan) - thus surprising the investors that for once, they aren't at the front of the line. This is something I expect we'll see more of later this year, from companies where debt and convertible debt are sitting ahead of the institutional investors. It will be interesting to see how the VC community reacts to these new circumstances, and how they explain it to their LPs.

As for the customers and their refunds? Apparently there is over $25m in the company accounts, with the accounts now frozen other than to pay employees and debts, so once there is at least a chance customers will get some money back. Glad to see consumer protections working, while we still have them that is...

No comments:

Post a Comment