11 Oct 2017

Tech transfer is a place where two worlds collide. At opposite ends of the spectrum, business and academia must meet in the middle to implement a successful spinout. Getting to that point requires each party to be patient and most importantly, understand each other’s needs and expectations from the outset.

This is especially important for founders who have many roles in the spinout process and must carefully manage both the university and their investors. So, if you’re a member in the founder team, here are 10 of the top things you need to consider:

1. Conflict of interests

Founders will continue to be academic researchers as well as consultants to the spin-out.  They will have an interest in the success of the spin-out wearing both these hats, so will need to manage that potential for conflict. This dual role also means that they may need to handover the responsibility for running the business to someone else in due course. The founder is more often playing a technical and strategic role, not a day-to-day managerial one, so shouldn’t expect to second-guess the CEO when the CEO makes decisions.

Likewise, founders must recognise the difficult balance that a university or its technology transfer office (TTO) has to strike.

On one hand, a TTO must take into account the expectations of the creators of the IP who are being permitted to exploit the commercial opportunities presented.  On the other, it will need to ensure that research, which may have received substantial public funding, is used in a way that meets the university’s wider academic aims.

Failing to understand these conflicts can result in unrealistic expectations about the nature of the deal and timescales, which can slow the spinout process.

2. Deal structure

You may have received some sort of agreement in principle to proceed from your heads of department or TTO but the deal may still need further clearance at a more senior university level, and the finer detail will need to be agreed.

Even if you have reached a formal agreement with the university, it may include concepts which you are unfamiliar with so take professional advice.  For example, the dilution of shareholdings, and what happens to each party’s shares over time, can surprise founders who don’t understand that a shareholding which seems generous at the outset, may become much smaller as funding rounds occur.

Another particularly complex issue is how to divide up equity between founders who may have made different contributions, and how to allocate equity (and/or share options) to important advisers and new team members. It is important in this context to reflect actual value received.  If there is an element of “sweat equity”, consider clawing back equity in the event of early departure.

Investor expectations must also be discussed in detail before finalising the deal, including on matters such as share structure, control, and warranties, and how these will affect any agreement with the university.

3. IP transfer options

The most fundamental issue to resolve is how the IP will be transferred from the university to the new company. There are two options – assignment or license.

An outright assignment is rare but preferable for founders as it gives the company greater freedom in relation to the technology. Investors usually prefer to invest in a company which owns and has freedom to use all of its assets.

Alternatively, a license gives the university a greater feeling of control and the ability to licence the IP to someone else if the original licensee fails to commercialise the IP.

With either option there is the opportunity to benefits from royalties as well as the chance to be a shareholder in the spinout business.

The licence can be exclusive or non-exclusive. If the university agrees an exclusive licence, it may however, wish to limit it by territory or field of use. The company will also be required to agree to certain performance criteria (“diligence”) often linked to sales or revenue or other commercial exploitation of the technology. Failure to meet the criteria could end the license.

In some cases, a non-exclusive license is agreed but these are unattractive to investors as it will enable the university to transfer the technology to competitors, so should be resisted by the new company.

4. Nature of the technology

Issues regarding the technology description usually surface at the document stage as prior to that there has rarely been the need to formally identify its scope and ownership structure.

The definition, or scope, of the technology is key for determining what exploitation is royalty bearing.  This can become more of an issue when the description of the technology is inserted into a schedule late on in the process.

Technology definition is also important so as to ascertain who owns it. Issues here include who the actual inventors are and who funded the research in question.

Ensure these issues are identified and flushed out at the heads of agreement stage.

5. IP infringements

The spinout company must ensure that is has the right to take action against a third party if it infringes the transferred technology and legal advice shows that it has a reasonable chance of success. This is particularly relevant where the licence is field restricted so there may be other licensees.

If the new company is the only licensee, a university is usually happy to give it this control but if there is more than one licensee, it becomes more complex. An agreement between the licensees governing how they could proceed is advised.

IP insurance is also an option and for spin-outs the cost may not be prohibitive, so this is worth considering with insurance specialists.

The most fundamental issue to resolve is how the IP will be transferred from the university to the new company.

6. Warranties

Although you and your investors will want to see some warranties (contractual statements of fact) regarding the asset you are licensing, universities are reluctant to give any extensive warranties as they are so risk averse.

This is an area that is likely to require some careful negotiation particularly for warranties covering ownership, infringement, validity and freedom from encumbrances. Do expect a warranty as to ownership at the very least!

7. Financial terms

The most popular payment model balances the interests of both parties by giving some combination of equity, milestones and royalties. The university obtains a basic return to cover its investment in the technology and a reasonable contribution towards the tech transfer process as well as share if it succeeds. Founders of the new company also benefit as expenditure is reduced in the early years.

As the royalties are dependent on the product being sold, expect the university to also put contractual obligations on the company to develop and sell the product – diligence mentioned above.

8. University’s rights

You will need to establish what continuing rights the university will have to use the IP. It is normally agreed that the university can continue to carry out non-commercial research and teaching using the transferred technology. But investigate whether there are any existing projects such as PHD theses which need to be completed. If so, specific rights should be carved out of the transfer agreement.

The university will also stipulate that they can publish the results of their research unless there is a good reason not to. However, a spin out company should insist on being given notice of any intended publications and on having the opportunity to delay publication if required, for example to obtain patent protection.

Improvements are another area of possible contention. Academics will want to keep working in their field to further develop the technology, but your investors may want access to those potential improvements to prevent them from being offered to a competitor.

9. Tax

There are various highly-favourable tax incentives which UK start-ups can take advantage of. These tax reliefs can turbo-charge your fundraising (e.g. SEIS/EIS) and R&D activities (e.g. R&D tax credits, Patent Box). If you’re an academic doing a spin-out for the first time, seek help and talk to an advisor at an early stage.

10. Timing

Although you will want to proceed as quickly as possible, you will need to be patient.

Identifying appropriate and interested investors and obtaining suitable investment terms can be a lengthy process. As highlighted above, there can also be many points of difference when negotiating with a university which need to be considered, discussed and agreed.

Key to success

When a long-established university spins-out and teams up with a brand new start-up company, it’s inevitable that there are going to be many differences.  The key to making the spin-out transaction go smoothly is for both players to understand these differences and what is trying to be achieved.

There are clearly many potential issues that you will have to address along the way but recognising these from the outset, will help you to plan and implement your deals in a smarter and more decisive way, ensuring a smoother and ultimately more successful spinout process.

With thanks to Alex Smeets, Associate of Cambridge Enterprise for his contributions to the article.