In the latest in his series of regular columns Burke Files casts his expert eye into the world of inventions and states how the instincts of the professional play a crucial role in the due diligence process.
I have had the opportunity to have been part of teams that have performed due diligence investigations into one or another given invention. I say opportunity because it is really a treat for me to meet with and speak with those people who are the irrepressible tinkerers and thinkers as they work to invent the future. Their levels of mental acuity as well as their descriptions of that moment of glorious insight provides for thrilling research, well at least thrilling for me.
Last month I was again part of a team looking at an invention. This invention was a significant part of why a company, my client, was looking at this other company as an acquisition target. As I did the work, I had come upon an anomaly. The anomaly was her behavior, the anomaly was the inventor’s reticence to discuss her work. The inventor was not at all what I have come accustomed to encounter, she was reserve and did not want to speak about the invention or the tinkering and thinking that went into her moment of glorious insight. Most investors I have worked with in the past were excited that someone was interested in their work and that their work might bear significant tangible benefits to them. Frankly, I thought her reticence was the result of something I said or did, or did not do. My lack of formality has been seen as rude or dismissive in the past, but that initial impression wanes when the subject realises that I am genuinely and enthusiastically curious about what they do, who they are, and the provenance of the invention. So I asked co-workers and the current employer if they knew if I had offended her and if so how I may have offended her? Her reply, through the grape vine, was that she was not offended; she just did not want to discuss the research or the invention.
Alarm bells started going off in my head and I had no idea why. Yes, this was out of the ordinary and yes this was not what I expected - but this is no reason for me to be upset. Thus, I put my first impression to the side and I got on with the due diligence research of the laboratory manuals, notebooks and the chain of experiments and observations that led up to the discovery underpinning the invention.
The work was flawless and elegant and very well documented. What the documents failed to contain were the blind alleys, the proposed hypotheses crafted, tested and discarded. These blind alleys are useful in their own right. The blind alleys or failed hypotheses show what does not work, so these failed experiments need not be repeated. The blind alleys may also give rise to patentable claims to “ring fence” the primary claim. But what we are focused on as a due diligence team is the string of work leading up to an event called the “reduction to practice” and the date the invention was reduced to practice.
The reduction to practice is a concept aimed at the initial embodiment of an invention. A successful “reduction to practice” event requires that the claimed invention can be clearly demonstrated to work for its intended purpose. A working model would be a strong claim in the process of illustrating the reduction to practice of an invention. A reproducible experiment that can show the reduction of a theory to a practice would be an excellent illustration of reduction to practice and if this invention were to seek a patent, the date of the first reduction to practice event is critical to the determination of the priority of claims between inventors in any interference proceeding.
The notes on the research failed in my mind as the notes were devoid of laboratory litter, errors, failed experiments and the inevitable stains from lunches eaten while making notes, coffee to keep working, and lab chemicals. Further, the reduction to practice, absent the failed hypotheses, felt contrived.
I raised these issues regarding the perfect notes with the CEO of the company and the inventor at the first “all hands” due diligence meeting. I was expecting my Perry Mason moment where the CEO yelled “You suits don’t understand” and she, the inventor, would then drop to the floor in a blubbering mess confessing her scientific sins. Well that did not happen. The CEO and the inventor both smiled and let me know that every night all of the raw lab notes were re-written by the interns with specific instructions not to include the failures, as most investment bankers do not understand failures or the value of the failures. In short, as the CEO said, he had two sets of “invention books” one from the lab and one dressed up to show others. While the answers were the same, the presentation of the clean set of notes was tailored for a given audience. The CEO gave me access to the full raw lab data and I found what I needed to find. The evidence in the raw lab notes, complete with stains, clearly demonstrated that the invention was the result of their efforts and the age-old process of coming to a glorious insight remained true. The glorious insight was at the end of a path consisting of lots of work and lots of blind alleys.
The inventor never did come around to see me and talk about her invention, or anything else for that matter. She came to work and did her research and left. She spoke to almost no one even in the company. The acquisition of the company went through and I have not been called to give testimony in an invention fraud case so I assume all is well. I re-tell this story as an illustration of two key points of due diligence.
The first is the history of an invention. Each invention follows its own path but those paths have similar features. Those features are lots of work, many blind alleys, and many hypotheses tested and discarded before one arrives at the glorious insight and its reduction to practice. The lab litter accumulated is much like the sawdust accumulation when making wooden furniture. It is part of the authentic process, it is there and you just must find it to assure yourself you are in the right place. I have come across inventions with no lab litter. These inventions turned out to be taken (stolen) from other locations such as universities and former employers where the new company/person has tried to pass this perfect work off as work of their own.
The second is the value of the instincts of a professional or expert intuition. These instincts are accumulated through a saturation of deeds and years in a given field. Little clues are accumulated by the professional mind sorted and ordered in the subconscious mind without the owner of the mind even knowing that it is happening.
Effective due diligence blends both types of thinking. Good due diligence thinking is a mixture of intellect, reason and cognition working with instinct, gut reaction, and intuition. All of this effort is aimed on figuring out the right questions to ask.
L. Burke Files Burke Files has been involved in finance since 1982 and in international finance since 1986. He has also served as the Director of Corporate Finance for an investment banking company; President of a business and venture capital consulting firm; and a commodities specialist trading gold, silver, and foreign currencies 24 hours a day. In the past, Mr Files has served as a member of the Governor's Board on Solid Waste Management; as an advisor to the Governor's Board on Economic Planning and Development; and as a former Commissioner of the City of Tempe Transportation Commission. Mr Files has also received a Commission and a Medal of Merit from the President of the United States. He has written extensively and been quoted in many publications. He is a frequently quoted source for articles regarding financial investigation and due diligence. Among the publications in which he has been quoted are: Chief Executive Officer, The American Southwest Quarterly, Offshore Journal, Cayman Today, Aegis e-Journal, John Cooke Fraud Report, El Cosario, European Business, NPR Market Watch, Bloomberg, USA Today and Associated Press. In addition to numerous published articles, Mr. Files is the author of many articles and several books including Due Diligence for the Financial Professional and Money and Budgets