Make sure you get what you pay for 

This is the second in a short series of posts examining what we believe makes for a successful university spinout, and flags some areas of contention with the recently published USIT Guide which seeks to standardise spinout structures and terms. This post considers the exact nature of SpinCo’s ownership of its IP. 

We were recently treated to a couple of hours of training in intellectual property law by IP lawyers Mathys & Squire (shout out and thanks to Anna Gregson), which was unexpectedly entertaining. One surprising view from the market was the practice in the Golden Triangle, especially among the Big Three universities (Imperial, Cambridge and Oxford), of not assigning IP to spinouts on receiving funding.   

Well, what on earth are the investors getting if that’s the case? We’ll talk about structure first – assignment versus licensing – and cover payments (royalties and similar) in our next post. 

We thought it would be worth investigating the issue further, and setting out our own redlines on the subject (spoiler alert – we won’t be making too many investments in the Golden Triangle anytime soon).  

So what’s the problem? 

Universities prefer to licence their IP to a spinout rather than assigning it – in other words they don’t like making an outright transfer. That gives them more control, often they use the licence to drive more cash revenues from SpinCo, and they get to recover the IP if SpinCo hits the rocks. From their point of view this all makes good sense. But – for all those reasons and more – the licensing model works badly for SpinCo and its investors. We’ll go into detail below. First – how did this happen? 

What’s driving university policy? 

Frustratingly for many investors, the licencing approach was codified in recent reviews led by some of the sector’s larger VCs and a few mainly Golden Triangle universities, published as the USIT guide. This reflects in part some overseas representation on the group, including from Columbia in the US, and the consequent partial adoption of the American US-BOLT document – University Spinout Basic Outlicensing Termsheet.  

This substantial adoption of US practice seems to have been for two reasons. The thinking was seemingly as follows: firstly, the US is world-leading in terms of volume and quality of spinouts so we should copy them; secondly, standardisation is good, full stop, as it encourages quicker deals and provides a clear template to universities that do few spinouts. 

Superficially, fair enough, but these arguments don’t bear scrutiny. The US market offers many lessons, but if we’re to enhance the UK spinout market, we need to think carefully about which aspects we copy. The US-BOLT template is clearly not gospel, was hugely influenced by some imperious US universities, and ultimately is a collation of practice from a very different funding market. As to standardising the process, let’s remember again that the US has a very different style, not least being lawyer-dominated. In contrast, our own negotiations with the universities are conducted principal-to-principal and quickly. More importantly, if the university’s USIT-influenced starting position is uncommercial, then the investment process is actually lengthened because we need to unpick their proposal. 

So, on that point, what exactly is USIT’s approach to IP transfers.      

Golden Triangle / USIT approach to licensing versus assignment 

In fairness, the USIT guide notes that: 

• Its prescriptions are “intended to be used … sensibly by practitioners who must adapt to and recognise the specifics of each deal”. Unfortunately, though, we find in general that market-norms can effectively become mandatory which is a problem when the USIT guide is so very specific; and 

• Universities might contemplate the eventual assignment of the IP. The trouble is that the circumstances in which this might be triggered – as set out in the USIT guide and as seen in practice especially in the more prestigious universities – are demanding and costly, so unlikely to happen in the early years of SpinCo’s growth.   

In practice, therefore, the guide’s assumption is that an early assignment of IP isn’t going to happen. Two problems follow from this:  

• The USIT guide recommends that the licenses require payment from SpinCo to university. We’ll cover the in our next post; and  

• There are practical issues in developing an IP portfolio based on licensed versus assigned IP, covered in the next section.  

Why assignment versus licensing? 

Assignment (assignation in Scotland) represents transfer of ownership of the IP. In contrast, a licence just grants rights to use the IP. In theory, the grant of rights could be so extensive that it substantially replicated ownership but, in practice and putting aside payments for now, licences usually come with serious drawbacks. 

Conditionality: a licence is a grant of rights that can be revoked in certain circumstances. From the university’s point of view, this conditionality can be used to regain the IP from SpinCo in the event that, say, SpinCo fails. Other common triggers include failure to commercialise the IP, or breach of any one of a bunch of other conditions such as not bringing the university into disrepute, or failure to pay royalties. That works fine for the university, and helps it fulfil its role of careful steward of its assets. But for the investor and SpinCo itself it creates serious drawbacks: 

• The conditions under which the IP can be whisked back are in large part outside SpinCo’s control. If, say, some pre-clinical trials give negative results, should SpinCo be further handicapped by its IP being withdrawn due to making inadequate progress? Similarly, if there is a funding desert (as there has been in the life sciences market in recent years) should the university be able to administer the deathblow by pulling the IP? 

• It follows that, if access to the IP isn’t assured, then SpinCo’s management and investors are building a house on sand. Why should management devote their careers, and investors their capital, to building a company that can be brought crashing down by the university taking its ball home? 

• Third parties building on SpinCo’s IP face a similar dilemma. If SpinCo is successful in proving its technology, the next step usually would be to pass the IP over to a Big Pharma for them to commercialise. At that point, lack of clear ownership of the IP is a blocker to deal-doing. A typical university-SpinCo IP licence will contain wording such as “on termination, SpinCo will ensure that its sub-licensees cease using the patent rights in any manner whatsoever”. Why should Novo or AZ write a big cheque and devote years to a partnership with SpinCo if their investment of time and money builds on a head-licence that could be withdrawn on a whim? This issue is also a problem on the sale of SpinCo or its IP. 

Our frustration with the conditional nature of the licence is even deeper because of the near certainty that any IP recovered by the university on a breach of the licence would almost certainly be worthless to them. If years of investment and effort by a dedicated team who are expert in the technology fail, why would the university’s tech-transfer office fare any better? 

Lack of clarity: even if an eventual assignment is anticipated in the initial licence agreement, the terms of the assignment are usually not defined. In some cases, the initial agreement does not even specify whether any further payment will be required. “Terms to be agreed at the time” is an agreement to agree, so fails as a binding contract. In that case, SpinCo does not have line-of-sight on its IP. 

Restrictions: another blocker to SpinCo achieving its aims are licence limitations. One example might be a university retaining the right to approve any parties to whom SpinCo licences its technology: does management really want its future partners to be restricted by the same political pressures that swirl around an academic campus? Another and more important example would be restrictions on the field of use. Assuming that the IP is early-stage fundamental technology, then SpinCo’s efforts and cash investment will transform the IP from basic idea to commercial reality, so it should be free to reap all the rewards. Restrictions on the field-of-use make more sense in the context of proven technology being licensed by the university to a company that needs to fill a particular technological hole. 

For clarity, this isn’t really an assignment-versus-licence issue as the restrictions in a licence could largely be replicated as covenants on an assignment. That said, as ownership is 9/10th of the law1, conditionality has more bite in the case of the licence: contrastingly, after assignment, the university might pursue a case for breach of contract, but SpinCo would continue to own the IP. More importantly, by custom-and-practice, a licence tends to be subject to more restrictions and conditions than an assignment.   

“We’re on your side – we’ll sort it out when the time is right”: In mitigation to all the above, the university routinely offers to be a friendly partner but, when the time comes and serious money is at stake, just how friendly will the negotiations be on any of the above points? And as with any contract, nothing survives but the wording. The personnel involved at the time of the spinout will move on, the context of the licence will have been forgotten, and the culture and motivations of either party may have changed. 

DSW Ventures’ approach 

We understand the universities’ position: they are charities, and their IP is often co-funded by other charities or public bodies. They and their officers are obligated to get full value for any IP passed over to a spinout. Hence the tentative nature of the IP transfer to SpinCo: if the patents for the cure for old age are assigned to a £1 off-the-shelf company that just sits on the shelf, then clearly the university would have failed to get value.  

That said, holding back the IP till the series Z round, or until SpinCo exits, is hardly conducive to SpinCo achieving its goals. The terms of the licence make it self-defeating. 

Our approach is that the university should commit its IP unconditionally and absolutely through an assignment as soon as SpinCo raises any meaningful funding. The consideration for doing so should be by way of the shareholding. This aligns financial interests: whether we as investors have put up cash, or the university has put up the IP, we all stand shoulder to shoulder as shareholders.  

Round up 

In recent years we have seen the regional universities become more comfortable with the idea of the unconditional transfer of IP for shares alone as being a fair-exchange. Our concern is that the USIT guide’s application of Golden Triangle norms will reverse this process, and make investments harder to close, not easier. 

David Smith 

Partner, DSW Ventures