Imagine you are a Dutchman in 1636. You know perfectly well that tulip bulbs are worthless. But you also know that any tulip bulbs you can buy now you can sell at a vast profit later. What do you do?
This is a false dichotomy. Unlike tulips or public company equity, startup equity is highly illiquid. It's hard or impossible to sell it an attractive price as an investor. Sure, later investors may invest at a higher valuation thus increasing the value of your holdings on paper but it's exceedingly rare for later investors to purchase equity from earlier ones.
In order to get liquidity, you need to have your portfolio company have an exit, either by IPOing or being acquired. Good luck having either of those two events with an entirely worthless company. Even if you do, it's fraud and people will sue you and government investigators will kick down your door.
I think most of the other commenters here are on the right track. VCs just don't do that much diligence for early stage companies, especially if they have a compelling emotional pitch. Hell, I wouldn't be surprised if someone flagged that their technology was impossible and a partner pushed ahead with the deal just in case of a miracle. There's so much money chasing returns now that $10MM is a pittance for venture funding.
Right. You just don’t want to be holding the bag when the wheels come off. It was the same with CDS’s in 2007. People who got out at the right time made fortunes. Theranos was another example of experienced investors hoping the bubble would last just a little longer than it actually did.
The simplest answer is the most likely: they weren’t.