A guest blog by Andrew Douglas, Browne Jacobson answering the question 'What ingredients do universities need to generate equity from their Intellectual Property?
A common theme throughout the PraxisAuril conference this year was spinouts and the relationship between the founding stakeholders. This conversation has spilled out into a lively discussion on the PraxisAuril community discussion online following the popular and oversubscribed pop-up meeting on “Busting myths and moving on: the reality of UK university approaches to taking equity in spinouts”.
We have commented on four key ingredients that, in our experience of advising higher education institutions (HEIs), academics and investors, are vital to ensure a successful spinout for all involved in the spinout journey:
- An agreed purpose
- A well-thought-out governance and equity structure
- An Intellectual Property (IP) Strategy
- A growth plan and exit strategy
An agreed purpose
At the outset, it is important for all founding stakeholders to be on the same page in terms of the role of each party, how the stakeholders will work together, expectations for the spinout and responsibility of each stakeholder. These can be documented in memorandum of understanding (MOU), also known as a letter of intent or heads of terms.
Whilst a MOU might sound like a complex legal document, it is not designed to be legally binding. It is a formal document that allows parties to set out and agree sets of terms that sets out how the spinout will operate in practice. This document helps to avoid future conflict causing the spinout or relationships to break down during the process by allowing the stakeholders to bottom out any potential issues early in the spinout journey.
Well-thought-out governance
From the start of the spinout journey until exit (whether by way of acquisition of shares or the business of a spinout or, if particularly successful, via an initial public offering), the hopes and expectations of all those involved are high.
HEIs do not take the same approach when it comes to their involvement in and control over spinouts. Some HEIs choose to take a more ‘hands-off’ approach, allowing the academic(s) to control the director led day-to-day decisions of the company and instead take a shareholder only function where they receive renumeration of any income generated from the spinout or royalties from intellectual property licenced to or by the spinout. Again, the percentage of the royalties varies from HEI to HEI. Other HEIs, prefer a more ‘hands-on’ approach in relation to governance controls with the benefit of various consent rights or vetoes over the activities of the spinout.
It is important to note that the agreed controls can change very quickly when a venture capitalist or other funder is required to inject investment into the spinout, these types of investors will likely have their own opinions on governance and would tend to take the lead on these matters.
A robust equity structure
Having a robust equity structure to facilitate growth is important to have in place from the beginning. However, like with the governance structure, this structure could change if further investment is required. To allocate each stakeholder’s share of the equity, it is important to appreciate the motivation behind why each stakeholder wishes to have their input rewarded. By the time an idea is ready to spinout, a HEI has invested a significant amount of money, facilities, and time from a variety of academic disciplines and employees.
As a result, a HEI is likely to wish to be rewarded for putting forward this investment upfront in the spinout often before any return on investment is guaranteed. Similarly, the academics and other members of the HEI whose idea sparked the spinout wish to be remunerated for their time, expertise and hard work driving the spinout to arrive at the moment of spinning out and commercialisation.
However, the equity is split between these stakeholders, it is important to bear in mind that future investment will often involve the dilution of the initial shareholdings. Future funders and the initial shareholders have a precarious balancing act of safeguarding a return on their investment whilst ensuring that all stakeholders still feel that they are remunerated fairly and remain motivated to keep the spinout spinning. One method of ensuring this balancing act may be to allow the founders more equity at the start and consider anti-dilution rights, ratchet provisions apportioning exit proceeds differently (based on the level of return) or even options which lapse at certain valuations to re-align all shareholders to exit expectations.
An IP Strategy
There is a very important difference between having an IP strategy and just protecting the spinout’s IP rights. The starting point for any spinout is to ensure its IP is protected in order to prevent and deter others from exploiting the spinouts core technology, brand etc. whilst simultaneously giving investors comfort that their investment is secure. Protection alone is not sufficient to attract investment, strategic consideration must be given to:
- Identifying the spinout’s IP
- Having a process in place to record and register the IP as it is developed
- The cost to register and enforce the spinout’s IP and
- The methods of commercialising the spinout’s IP (e.g., via franchising, licensing etc.)
A growth plan and exit strategy
Recent data suggests that only 10.4% of the UK’s spinouts have exited successfully[1], therefore, to increase to odds of a successful exit - planning is essential.
External investors will expect the spinout to be able to explain its growth plan and exit strategy which includes milestones and timeframe as well as an anticipated valuation at exit - this is to ensure that the investor’s objectives for the spinout are aligned with the expectations of other stakeholders. Without a growth plan and exit strategy a spinout lacks direction and could struggle to attract investment which is essential to keep the spinout going when the initial funding runs out.
Browne Jacbson has extensive experience working with universities, venture, growth capital investors and high growth tech companies in which HEIs hold shares. Find out more about how we can help with your spinout strategy here and consider watching our free webinar here.
In the meantime, if you have any questions, please feel free to get in touch with Sam Sharp or Selina Hinchliffe.
