Dr Ian Muirhead

Dr Ian Muirhead reveals what he wished he'd known when starting up his business.

When first asked to recall things I wish I’d known, I thought of many things. But after further thought, there are two which if I had known in my earlier years would have made subsequent situations a lot easier.

The first is the need to have IP assigned to the company at the outset. The second is the importance of understanding where a VC is in its fund investment cycle when it makes its initial investment in your company.

Assigning IP

The starting point for most academic university spin-out companies is the negotiation of the licence to the technology that the new company (NewCo) is going to be built on.

IP assignment is often the main point of contention. It is very important to get this cornerstone of the NewCo right, if the company is to be attractive to potential investors. You need to avoid having to re-negotiate aspects of the licence agreement down the line before any VC investor will put their money into the company.

Below I have somewhat unscientifically identified what are hopefully some nuggets of hard-earned wisdom to help make the slogging part a little easier.

Every university has its own approach and views on the routes of licensing their IP. If the principal of a spin-out company has been agreed, and it is known that the NewCo will require VC funding to grow, then certain parameters need to be taken into consideration; IP assignment being one of them.

There is no blueprint on negotiating the assignment but industry or market sector norms for royalty on sales of the product are a good starting point.

All parties are looking for a fair and equitable return taking into account; (i) the relationship between the expenditure to establish the IP position to date and defending it in the future; (ii) the expenditure required to develop the IP to a marketable product; and (iii) a return (though their positions may differ on what that means) on these investments taking into account the associated risks involved.

Parameters worth considering when negotiating various trade-offs in the licence agreement would include:

• What is its perceived value, i.e. how fundamental is the IP that is being licensed to the product and market sector?
• What equity will the university hold in the NewCo?
• What royalty on sales of the product will the university receive?
• Will future IP developed at the university (by the originators or others) be accessible to the NewCo? This could be through direct access on equivalent royalty terms or right of first refusal for emerging IP in the same product or market space as the NewCo is operating in.
• Assignment; at what stage and under what terms (the most fundamental being at what price) will the IP get assigned from the university to the company?
• Is there an end point to the period of royalty payments and/or is there an agreed formula to buy-out future royalty payments?

Often these last two bullet points do not get sufficiently defined at the outset of the licence. Many VCs have had bad experiences of dealing with assignment of IP just before a trade sale or IPO, where "the company is held to ransom" and this has made them particularly sensitive to these parameters.

The licence negotiation process is further "complicated" by the fact that the founders are often negotiating with the university (their employer) on behalf of themselves and on behalf of NewCo.

Equally if the mechanism for the IP assignment is not agreed at the outset then the university in due course will find they are negotiating with the NewCo as both owner of the licensed IP and shareholder in company. This can lead to conflicts of upfront at the time of negotiation of the original licence.

Universities are often reluctant to assign IP to early stage companies for fear that the IP the company failing or because the IP is shelved. The VCs desire to have the IP assigned at the time of investment often increases with the amount of money they need to invest in NewCo to take the product to market. Scenarios and timing of IP assignment to NewCo can include:

• At the time of the investment or at a time when an agreed sum has been invested in the company;
• After an agreed time period;
• After an agreed minimum royalty or equivalent monetary sum has been paid to the university;
• When the company has reached an agreed valuation point.

I have encountered this last situation more than once and my recommendation would be to get a licence negotiated at the outset which has a clear and workable mechanism for assignment of the IP to the company and has capped royalties (by value or time) or an agreed mechanism for their buy-out. This will reduce the need for a re-negotiation before a VC fund will put money into the organisation.

Fund Investment Cycle

The second point is the importance of knowing where a VC fund is in its investment cycle when it makes its initial investment in your company.

The ideal scenario is to be an early investment in a new large fund from an investor with industry sector experience. To reduce a VCs risk of subsequent dilution in future funding, they always prefer to be able to follow on their initial investment should that be required.

The risk profile the investment fund will adopt tends to be higher at the start of their fund investment cycle than mid way through. However if a fund’s portfolio of investments is doing very well 75% of the way through the investment cycle then this risk acceptability can rise again for later investments. This is provided the fund has sufficient monies left to follow on its investment should it be required.

Problems can arise when your chosen VC has invested in your company from one fund and wants to add to that investment from one of their later funds. Most, if not all, VC funds are set up with clear defined rules about how they can cross invest in portfolio companies from different funds.

Typically one fund cannot invest in a company already invested by another fund from the same VC house, without a third party setting the price.

This is done to avoid the original investor using an alternative fund they manage to shore up their initial investment. This in principal sounds fine as long as a third party investor can be found in the timescales required, and that the third party investor sets a valuation on the company that is acceptable to the company and the original investors.

My recommendations are where possible take your investment from a fund that is at the early stage of its investment cycle; where this is not possible then go into it with your eyes open and try to fully explore the possible scenarios of future investment rounds and how the VC would handle them.