Elizabeth Holmes set the biotech investment world on its head when she announced that her company had developed a small machine capable of performing hundreds of blood tests on tiny blood samples at a greatly reduced cost. Her company
Theranos (a portmanteau of “therapy” and “diagnosis”), immediately began receiving investment capital. These investments eventually totaled over $700 million, skyrocketing the company’s valuation to over $9 billion. But it was all based on a lie. Ms. Holmes had no machine with these capabilities. Not only did such a machine not exist, but an expert in her own company admitted that producing a machine, in such a tiny form factor, with all of its claimed capabilities, was simply impossible.

So how did Elizabeth Holmes and Theranos raise hundreds of millions of dollars based on technology that it did not, and would never, have? As detailed in the new HBO documentary The Inventor: Out for Blood in Silicon Valley, there are several reasons Theranos was able to receive so much money, based on so little technology. One reason was Ms. Holmes’ cult of personality, that kept investors from questioning why the Emperor had no clothes. Another reason was her ability to attract powerfully influential board members, like Henry Kissinger and George P. Shultz, who understood little about biotech, and even less about Theranos’ calims of a tiny miracle machine. Ms. Holmes also brought in investors who, after investing large sums of money into Theranos, had a large incentive to convince new investors to invest even more money, thereby dramatically increasing the valuation of their initial position.

So why did none of these investors confirm that Theranos’ technology actually existed, or that such a technology was even theoretically possible? It appears that instead of conducting sufficient due diligence of Theranos on their own, investors may have blithely relied on the mistaken assumption that at least one earlier investor, in at least one prior Theranos investment round, did confirm that the technology existed, or was at least theoretically possible. So what about the early investors? Why did they not demand to see evidence that the technology was viable? One reason may have been the complexity of the technology and the patents that allegedly protected it. If the company holds multiple patents and employs experts in the field, such as former Stanford chemical engineering professor Channing Robertson, the technology must exist, right?

The problem investors failed to realize is that patents are no indication that a technology exists, or that the technology is even possible. There is no requirement that you have a prototype, or even prove the technology works, before the United States Patent and Trademark Office (USPTO) will grant you a patent. There is a requirement under 35 U.S. Code § 112(a) that a patent contain a written description of the invention and the manner of making it “in such full, clear, concise, and exact terms as to enable any person skilled in the art to which it pertains [….] to make and use the same.,” but you only have to state that. You do not actually have to submit any proof the technology is viable unless the USPTO requests it. And why would the USPTO request it? Why would anyone spend so much money patenting technology that does not exist?

Now if an examiner at the USPTO became aware that a particular technology is impossible to make or use according to a patent application’s written description, such as in the case of applicants trying to patent perpetual motion machines, the examiner will refuse to grant a patent on the technology. The problem is that patent examiners at the USPTO have no ability to use the written description of a patent application to try to actually build or use the claimed invention. In many cases, especially in the case of complex technology, confirming the patent accurately describes how to make or use a viable technology would require massive amounts of time and money to produce a prototype. Given the rarity of applicants spending massive amounts of money try to patent a technology that does not exist, forcing the USPTO to conduct experiments to determine the viability of every claimed invention would be a massive waste of time and resources. The USPTO is, therefore, left with no choice, but to assume that the patent applicant has described the technology in the patent application sufficiently to allow a person of ordinary skill in the art to produce the claimed technology.

Why is this not a bigger problem? Why are more companies not getting patents on vaporware? First, a patent only gives the patent owner the right to stop someone else from making, using, or selling, the technology claimed in the patent. If the technology does not exist, the patent owner has no rights to enforce. Second, if a patent owner were to get a patent on fake technology and then try to enforce its patent against a competitor making a different product, the competitor would investigate the patent, and call in experts to invalidate the patent in court, by proving that the description in the patent does not describe a technology in such full, clear, concise, and exact terms as to enable any person skilled in the art to make or use the technology. So even if the USPTO were to grant a patent on a technology that does not exist, the market would ordinarily weed out those patents before they can do any harm.

But what if a company obtained a patent on an impossible technology and never tried to enforce the patent against anyone? What if the company simply touted its technology as “patented”?

Many investors hold tight to the mistaken belief that the USPTO vets patents to make sure the technology claimed in the patent is real. They erroneously rely on the USPTO to do the complex, costly, and time-consuming due diligence that would be necessary to ensure a technology is viable. Many investors view a patent as a seal of approval from the government that the technology is real and no competitors are allowed to compete in the marketplace.

In actuality, a patent is no guarantee that: 1) the technology is viable; 2) that the patent is valid; or 3) that a competitive technology is infringing the patent. While a patent is presumed valid, if a competitor can present a court with evidence that the patent covers technology that was in the public domain, the court will invalidate the patent. Similarly, a patent can be broad or narrow. A broad patent provides its owner with a monopoly not only on the exact technology, but on alternative technologies a competitor may try to implement to get around the patent. Conversely, a narrow patent allows competitors to change one or two minor elements of the technology to legally circumvent the patent. The breadth or narrowness of a patent determines the scope of the monopoly the patent provides over competing products. Whether a competitive technology infringes a patent or not is determined by a judge or a jury, after reviewing all of the evidence.

Investors, therefore, need to be aware that patents are no substitute for the due diligence required to determine if a technology is real. It is simply not the USPTO’s job to determine the viability of a technology covered by a patent. Investors need to realize what patents represent and what they do not. When the USPTO grants a patent, it is simply stating that, based upon the USPTO’s necessarily limited investigation, the USPTO has not found any evidence that the patent is attempting to cover technology that already exists or that will never exist.

From a technology viability perspective, a patent grant is similar “not guilty” verdict in a criminal trial. A “not guilty” verdict is not a certification that the defendant is innocent. It is simply an indication that there was insufficient evidence to find the defendant guilty. Similarly, a patent is not a certification that the technology is viable, just that the USPTO has not been presented with any indication the technology is not viable.

While most of the blame for the massive Theranos investor losses rests with Elizabeth Holmes and Theranos, some of the blame rests with the investors themselves. This blame rests with Theranos investors failing to conduct sufficient due diligence and for failing to understand what a patent means and does not mean. Investors, especially when investing in complex technology, must conduct their own exhaustive due diligence into the viability of the technology. In today’s complex investment market, there is simply no excuse for investors failing to understand the interplay between patents and technology and how patents do, and do not, factor into proper due diligence protocols.

Brett Trout