“More is less”
We’ve been busy these last few months, and temporarily off the airwaves (for the younger reader, this is a reference to broadcast radio and TV: ask your parents or try Wikipedia for more information, if you can tear yourself from your latest TikTok challenge). We’ve spent that time completing some more investments, including another university spin-out, and thought it worth sharing a few thoughts in this short series of some of the challenges about taking tech from the lab through to a successful exit.
In this first of the series, we’re going to look at shareholdings: what’s a fair split between the university (or the corporate, or any other mothership) and management.
Who is offering what?
Let’s put aside the shareholding taken by any funders for the moment, simplifying the analysis to consider the contribution made by the two main initial groups on day one of the spin-out, before it takes investment:
- The owners of the intellectual property on one hand, and
- The management team needed to complete the development and deliver the commercialisation of the IP.
In practice, the analysis isn’t this clear-cut, because some management may have a foot in both camps: the inventors of the IP will often join the spinout’s management team. Equally, new management will be hired, not having any ab initio ownership of the IP. We’ll come back to this in a minute.
So, on the day that newco is formed to assume the intellectual property developed in the university, a decision needs to be made about the relative value of the IP and of the ongoing commitment by management to get SpinOutCo through to a successful exit. So first-off – who owns the IP?
The legal position varies massively from institution to institution, from a hard-core position (less common nowadays) that the university owns 100% of the IP generated by its staff, through to 100% ownership by the academic. The IP ownership position will influence the eventual shareholdings in SpinOutCo, although any university whose starting position is to take 100% of StartUpCo’s equity isn’t going to find itself a management team, nor any venture capital investors. Let’s take a look at the increasingly common position in which IP is split equally between the institution on one hand, and the investors – those with their names on the patent, typically, maybe the Professor and the post-doctorate researcher – on the other.
Just occasionally, the IP can have real value in isolation. This might arise if the invention were so fundamental that the world would beat a path to the inventors’ door. Take Graphene for example. Although, notoriously, the fundamental IP of Graphene was not patented. Oops.
But this hardly ever happens. Most university IP represents an incremental but not fundamental step forward, whether in efficacy, or efficiency, or applicability. It’s usually the case also that the innovation may not work – either it fails technically, or just proves impractical, or maybe the target customers take a look, yawn, and get back to what they were doing before they were rudely interrupted. So that’s why SpinOutCo needs a management team – to complete the research and prove the concept, to develop the concept into a workable application, and then to sell the hell out of it. And given the odds-against prospect of SpinOutCo actually succeeding, the years of hard work, and the relatively poor remuneration of working for a start-up, that’s why management need a big chunk of the equity.
It’s definitively NOT all about who owns the IP.
And what does that equate to in terms of a fair equity split?
Let’s recap: StartUpCo’s equity needs to reflect two major inputs: the injection of the IP from whoever owns it, and the ongoing labour and dedication of its management team. Some of the managers may also be part-owners of the intellectual property.
The non-subjective part of the analysis is remuneration for the IP. In the case above where the university owns half and the two inventors own the other half between them, the split of equity to reflect the IP injection is straightforward:
|SpinOutCo cap table|
|Shares for IP||%|
Then comes the subjective analysis – what reward for management? And, crucially, who is in the management team?
On that latter point, ideally, we want those two academics to come over to SpinOutCo, not necessarily because they are going to be great managers (although they might) but because they hold the keys to the IP – they know how to make it work – and they’re the gateway to future IP that builds on the original inventions and patents. Chances are that, without them, we just get a snapshot of the IP: what we really need is to secure the pipeline. So let’s assume they are appointed directors, and work at least part-time for SpinOutCo.
They’ll also need a technical team, so let’s assume that on day one they transfer over a couple of researchers, who will also need enfranchising – so more equity for them.
Next, the operational and commercial team. Not all will be needed on day one, certainly not all on a full-time basis, but to get to an exit there will be a lot of equity issued to attract the right calibre of staff and management:
- On or shortly after spinout we would expect the company to hire a commercially-orientated director – maybe a CEO with an expertise of scale-ups and a broad range of general skills – as well as a couple of non-executives with sector experience, and maybe a part-time FD-cum-commercial director. They will need shares.
- And prior to a series A, a whole raft of other hires including a Development Director, Head of Regulatory Affairs, and – crucially – a Chief Revenue Officer. We need to set aside an option pool for these hires.
So how much do management get for being managers? Well, let’s approach it the other way round: how much does the university end up with? The answer is, of course: “it varies”. But it varies less than it used to. A useful study was published recently, showing a steadily declining initial stake taken by universities generally, and currently averaging about 20% of the issued share capital, with the academic founders getting an average moving towards 60%. Working these figures backwards gives the following illustrative, cap table for SpinOutCo, before venture-funding and before allocating an option pool for future hires:
|SpinOutCo cap table|
|Share for IP||%||Shares as managers||Total shares on spinout||%|
The take-away is to note that management – both commercial and academic founders – are getting the lion’s share of the equity, and getting it in return for future service, not as inventors. If a large option scheme were factored into the above cap table, the balance of equity as reward for services versus IP ownership would favour management in the ratio of around 2: 1. And quite right too.
One point we should make before signing-off is that the university may well have an ongoing contribution to make: we don’t regard their shareholding as “dead” but very much a bridge to maintain their goodwill. They may well have a significant future contribution to make in terms of facilities, access to future IP, and access to their staff. You should never burn bridges.
You can argue cause and effect but there’s a definite correlation between the volume and success of university spinouts and the trend towards increasing enfranchisement of management, recognising that IP doesn’t sell itself. UK universities are acting with enlightened self-interest, and seem to be benefitting both in terms of reputation and financially. Better to have a small stake in a unicorn than 100% of a patent.
Less is more.
Partner, DSW Ventures
About DSW Ventures
DSW Ventures made its first investment in 2018 and is an investor in early-stage scale-up businesses requiring venture funding of more than £250,000, primarily on an EIS basis. It is funded by a growing network of high-net-worth investors. DSW Ventures is a trading style of DSW Venture Capital LLP, part of the Dow Schofield Watts Group.
DSW Ventures is a partner in British Business Investments’ £100m Regional Angels Programme, designed to help reduce regional imbalances in access to early stage equity finance for smaller businesses across the UK. British Business Investments is a wholly-owned commercial subsidiary of the British Business Bank, the UK government’s economic development bank.
Dow Schofield Watts is a UK independent advisory and investment group, headquartered in Warrington, Cheshire and with offices in Manchester, Leeds, Aberdeen, and London.
British Business Investments is a commercial subsidiary of the British Business Bank. Its role is to increase the overall supply and diversity of finance – both product and provider – on offer to UK smaller businesses. It does this while providing value for money for UK taxpayers. British Business Investments does not finance small businesses directly, but instead works with the market to provide funding through its delivery partners. These partners offer a range of funding options for small and high-growth businesses across sectors, regions and business stages.