US universities take low equity stakes in the companies they help commercialise. But non-dilutive shares and royalties mean academic institutions ensure they receive payouts.
Stanford University has a storied history of spinning out successful companies such as Hewlett-Packard, Sun Microsystems and Cisco Systems. Its California location, at the heart of venture capital investment, means it is never far from investors willing to take bets on technologies emerging out of the private academic research institution.
But, despite its reputation for churning out successful spinouts, it won’t take large chunks of equity in the companies that it helps to commercialise. The technology transfer office asks for between 1% and 5% of equity in exchange for the licence to the intellectual property underlying the business. This is much lower than is common practice in other university systems such as Europe and Australasia where equity stakes as high as 40% or more are demanded by universities.
Those kind of high equity demands would be a hard ask in the US. Spinouts just wouldn’t receive funding from VCs.
“Usually, the VCs will complain if Stanford has too much in the cap table. And so that’s just the equity that the technology transfer office asks for,” says Cheryl Cathey, senior licensing and strategic alliance manager in the Office of Technology Licensing at Stanford University.
Equity stakes in the single-digit range are common across universities in the US. This in line with norms of venture capital investment practice, which demand that founders own most of the shares in their startups to receive funding. Venture capital investors argue that founders will be disincentivised to make their businesses a success if they don’t have majority ownership.
“Our goal is really to plant a lot of seeds. Get as many startups going as we can, because you never know whether they’re going to be successful or not,” says Cathey.
Low ownership stakes may be the norm at US universities, but this doesn’t mean that technology transfer offices are willing to sign off on deals that leave them without the chance of returns.
Non-dilutive shares integral to deal terms
It is common practice for technology transfer offices to ask for non-dilutive shares in spinouts, sometimes up to a series A funding round, an approach taken by Stanford. In some cases, non-dilutive share provisions mean that universities’ equity shares end up being worth as much as if they had taken a large, double-digit chunk of equity before external investors come in.
New York-based Columbia University takes 5% equity in all its spinouts, with anti-dilution through series A funding round. “The equity models in the UK and Australia don’t come with antidilution protection to the A round, and hence typically are larger. However, by the time the A round is done, these stakes are often equivalent,” says Orin Herskowitz, executive director of Columbia Technology Ventures, the university’s commercialisation arm, in an email.
Other bells and whistles are added to deal structures to ensure financial return for the universities. Stanford asks for rights to purchase up to 10% of the stock in its spinouts. “Some companies really like that because it helps them fill out their cap table. It’s only if they’re oversubscribed that they complain about that. But we’re pretty adamant that we keep that in there, unless they’re going for a round D or something like that,” says Cathey.
Lawyers also play an important role in making sure founders get favourable deals from universities. They will often offer free legal representation to founders in exchange for stock. “A lot of the startups use the same law firms. The law firms probably give them some cut rate deal,” says Cathey. “It’s unusual, especially if it’s a VC-backed startup, for some company to come into a negotiation without one of those big law firm on their side.”
Royalties are included
To sweeten deals, US universities typically ask for royalties or a percentage of net sales. Technology transfer offices will typically ask for a combination of equity and royalties, whereas investors in other jurisdictions generally prefer equity-only deals.
“For the vast majority of our licenses, royalties are part of the license agreement. There are a very small number of deals per year which are for industries or situations where royalties wouldn’t be appropriate, but very few,” says Herskowitz at Columbia University.
Royalties are usually part of the deal at the University of Pennsylvania. The technology transfer office, Penn Center for Innovation (PCI), will very rarely accept an equity-only deal. “Equity is just one piece of the puzzle,” says Benjamin Dibling, associate vice provost for research and managing director of PCI. Like other US universities, The University of Pennsylvania takes equity positions in the single-digit range.
“Under the licence agreement we are still going to ask for royalty on sales of products that are covered by the licenced IP. We may ask for certain development milestones when they’re hit by the company as the product moves towards commercial development,” says Dibling.
Other requirements the technology transfer office puts into agreements include maintenance fees for the licence. It may ask to be reimbursed for patent expenses. Sometimes it asks for a slice of sublicensing income for the technology. “All of these are different levers that we pull to arrive at an economic framework that works for both the university and the company,” says Dibling.
The Penn Center for Innovation spins out a small number of companies where it is actively involved in forming a business. In these cases, it will take a 49% equity stake while the inventor receives 51%. This ownership share is fully dilutable. In the end, if the company exits, the University is likely hold the same amount of equity as it would have done if it had a non-dilutable share through a licence agreement.
The case for standards
As in other jurisdictions like the UK, US universities have made efforts to produce best practices for licence agreements, including provisions for taking equity, royalties and setting milestones.
Biotech is a sector where guidelines have been translated into a US-BOLT (University Startup Basic-Out-Licensing) term sheet, a standard deal contract. The group that negotiated the guidelines, including universities, law firms and venture capital firms, also produced a sample template of a full licence agreement. The guidelines are meant to save universities on time and money during negotiations. Recently a US-BOLT term sheet was released for climate-related spinouts.
In the tough investment climate, VC-friendly spinout terms have taken on an even important role. Investors are emphasising the importance that founders have a good chunk of equity in their companies, so they are incentivised to work hard to make their companies successful. “You’ve got to have an approach of being flexible. You just have to, especially in the current financing climate. It is really tough.” says Dibling.
