Theranos Inc., the blood-testing company now infamous for allegedly being Silicon Valley’s biggest fraud, closed a deal late Wednesday with Fortress Investment Group LLC, a division of Softbank 9984, +4.72% and its most important creditor, giving the private equity firm ownership of the company’s patents but leaving its remaining cash — about $5 million — for distribution to unsecured creditors, according to a person close to the transaction.
Elizabeth Holmes founded Theranos in 2003, and was its chairman until the company’s final deal closed Wednesday. Holmes was indicted in June on several counts of criminal conspiracy and wire fraud. At that time she stepped down from the CEO role and Theranos general counsel David Taylor took over day-to-day operations.
Taylor declined to comment on the transaction beyond what was contained in a letter he sent to shareholders earlier this month.
Holmes settled fraud charges brought by the Securities and Exchange Commission in March. Ramesh “Sunny” Balwani, who served in various roles at Theranos until the end of 2016 including a member of the board, president and chief operating officer, is still contesting the SEC’s charges against him. Along with Holmes, he was also indicted by the Justice Department in June.
Theranos secured a $100 million loan from Fortress in December 2017, but distribution of the proceeds was “subject to achieving certain product and operational milestones.”
See also: SEC called Theranos fraud ‘massive’ — but didn’t get the company or its founder to admit guilt
Theranos received the first infusion of cash, $65 million, when that loan deal closed. However, the company burned through those funds pretty quickly, according to people close to the company’s operations, and existing investors were unwilling to put in more money when Holmes solicited additional support via a letter to investors in April. An effort to sell the company also failed.
There was no likely path to achieving the Fortress milestones — and getting more funds — before the company ran out of cash, according to several people close to the company’s finances. Even if Theranos had received the remaining $35 million by this summer, the company would not have had enough cash to support itself for the next 12 months, according to an audit opinion on the company’s 2017 financial statements delivered to management and the board at the end of June by OUM & Co. LLP, a California-based firm that serves several publicly-traded pharmaceutical and medical device firms.
The original Fortress loan agreement required Theranos to produce audited financial statements for 2017 with a clean opinion — reasonable assurance that the company’s accounts were free of material misstatement or fraud — by June 30, sources close to the transaction told MarketWatch. This was the first time the company had completed preparation of financial statements according to Generally Accepted Accounting Principles, the standard for public and larger private companies that solicit outside investments. It had also never received an auditor’s opinion on its financial information, according to people close to the company’s finances.
However, OUM’s audit opinion included an “emphasis of matter” paragraph that highlighted the existence of a material uncertainty regarding Theranos’ ability to continue as a going concern, according to people knowledgeable about the contents of that report, confirming executives’ fears that there would not be enough funding to commercialize the company’s products fast enough, and therefore secure additional funding from Fortress.
Fortress sees value in the company’s intellectual property and will likely seek a return on its investment by pursuing companies that have already commercialized earlier patents and request royalties, according to several people who are familiar with Fortress’ thinking.
A spokesman for Fortress did not respond to a request for comment.
The deal with Fortress uses “an assignment for the benefit of creditors” under California law rather than a bankruptcy filing to send the patents to Fortress in satisfaction of the loan, and the remaining cash and assets to a “newco” to be managed by an outside firm for the benefit of unsecured creditors, according to the letter to shareholders sent by Taylor about the proposed deal earlier this month. However, payments for ongoing legal fees for Holmes, Balwani and several other former executives and directors under indemnification agreements will be stopped, according to someone at the company who is familiar with the arrangements.
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