How To Negotiate University Spin Outs
Investment in UK university spin outs reached £1.11b in 2020, which is a significant increase from the £577m raised in 2011. Although the number of deals has decreased since its peak in 2017, university spin outs remain a popular and important method for UK universities to commercialise their knowledge and research.
This blog outlines some of the key aspects that founders should consider when negotiating university spin outs with the universities themselves.
Many aspects will have to be considered when creating the spin out company including:
- Any external commitments or conflicting objectives?
- The contribution each founder will be able to make effort-wise.
- Will the founders remain at university and work part-time?
- Who will become directors and can they?
- Are the extensive director’s duties understood by each individual?
- Who will have shares in the company?
- How many shares will each individual hold in the company?
- Who will have the power to pass ordinary and special resolutions?
- What type of consideration will be used to pay for the shares?
- Class of shares e.g. ordinary or preferred?
- What will the nominal value of the shares be?
Considering all of these questions will help place you in a better position to negotiate with a university, enabling you to understand what you want from any subscription and shareholders agreement(s) (“SSA”) as well as the articles of association.
Many founders with limited business experience also may not understand the impact of certain clauses in the SSA. Although significant shareholdings can look enticing, being aware of investor expectations and shareholder dilution will be incredibly important when looking for investment, which will have to be considered in any SSA with your chosen university.
This will take place amongst senior university figures, when agreeing the specific details in the SSA.
Transfer Agreement to Exploit IP
The main issue here is whether the IP will be transferred through:
- An assignment; or
- A licence.
An assignment will be preferable for any founder (although unlikely to be accepted) providing you with:
- Greater freedom due to limited control.
- Investors prefer to invest in a company that is free to use their assets.
- Gives something of value to sell if the company doesn’t work out and becomes insolvent.
- Quicker negotiations.
A licence is the most common form of transfer and one which a university will likely opt for due to the following:
- Greater control for universities, and an ability to participate in the business as a shareholder.
- Exclusive licences are the ‘next best thing’ if universities won’t accept an assignment.
- Non-exclusive licences should be avoided as future investors will find any investment less attractive, due to universities having the power to market the IP to the investors’ competitors.
- A trigger clause could be beneficial for the founders providing for assignment if a target or something similar is met, related to performance criteria.
Usually the payment model agreed with the university is a mixture of equity, milestone payments (for example when a sales or performance target has been met) and royalties.
The Technology Itself
It will be important to identify the scope and exact ownership of the technology being transferred in a document that usually is in the form of a licence agreement or an assignment of IP. There have been an increasing number of disagreements arising over this exact issue, and professional advice should be sought to make sure absolutely everything is covered within the agreement.
Other Important Clauses
As part of the SSA, universities commonly want to publish any research results. It would be beneficial for any founder to include in the agreement clauses that:
- Allow founders to have prior notice; and
- Provide founders with an opportunity to delay publication under certain circumstances.
If there are any other existing projects, making sure they can also be completed will be important.
If a third party infringes any IP rights, it should be provided for that the spin out company can act against such infringement.
Issues arise when there is more than one licensee involved or where the licence is non-exclusive. The spin out company should compel the university in such situations to act where there has been clear infringement of the IP rights in question.
The university and investors will typically seek a number of protections, of which you will need to be certain of the impact each protection has on the spin out company including:
- Requiring consent over certain company decisions, such as the winding up of the company, selling the company or in some cases extended to day-to-day operational matters.
- Rights to monitor important business documentation.
- Pre-emption rights to prevent the further issuing of shares to non-shareholders, thereby diluting the investor and university shareholdings. You will also likely be required to offer any new shares to current shareholders first.
- Tag along and drag along provisions will be important for the founder to ensure that when you choose to sell, the other parties can either join in or be dragged along with you. Selling the entire share capital will be much more attractive to future buyers, as opposed to a part of the company.
Warranties should be sought from the university to ensure that they have the requisite ownership and freedom to assign or licence the technology to the spin out company. This will be very important for any SSA and should be negotiated with care. Qualified warranties essentially prevent the founders from making the warranty in conjunction with the university, meaning you will be protected from third party claims.
As founders, you will also have to provide other warranties to investors and universities, primarily over company details and plans.
Restrictions to be aware of
Often to prevent the founders from damaging the company, the investors and university may use techniques to prevent you from doing so including:
- Positive obligations (to do something).
- Restrictive covenants (to prevent you from doing something) e.g. leaving and setting up a competing business.
As a UK start-up, certain tax reliefs may be available to you providing you satisfy the relevant criteria including:
- SEIS/EIS (albeit these tax reliefs are aimed at investors as opposed to founders); and
- R&D Tax Credits.
You must also be aware of potential employment income tax charges upon the share acquisition, due to the relationship you will have with the university. It will be important to check whether:
- Exemptions or tax reliefs available for spin outs under the Income Tax Act 2003 applies;
- Any restricted securities elections are made within 14 days; and
- Professional advice is sought to make sure no other circumstances exist to prevent any exemptions or tax reliefs from applying.
The list of considerations above are non-exhaustive and each spin out is different. There may also be particular importance attached to areas not discussed in this blog and there may be other key ancillary documentation to be entered into (for example a consultancy agreement or service agreement relating to work being carried out by founders in connection with the spin out, a research agreement where research will be conducted at the university and/or a facilities agreement where you will continue to access the university’s facilities).
If you are in the process of undertaking a spin out or would like to know more about the process involved, please get in touch with us at the Jonathan Lea Network by either sending an email to email@example.com or complete this form to arrange a free 20-minute consultation.
This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited 2023.