Legal Ninja Snapshot: Technology Transfers: How much should a University hold in its (University) IP-based Spin-Outs?

UK Research and Innovation (UKRI) has recently published a list of UK universities that have voluntarily adopted certain (supposedly) best practice policies for deal terms of research transfers to start-ups (we simply refer to them as "spin-outs"). In this snapshot, we look at these policies, specifically those around how much equity a university (or its transfer office) should get in return for its intellectual property (IP). We set the new UK approach into context with what we observe in international hotspots and discuss what can be learned for Germany.

Some Basics First – Understanding the IP-for-Equity Model and Dilemma

Spin-outs play a crucial role in driving innovation by translating university IP from academia into the private sector. However, IP created by university employees typically belongs to the university and the universities understandably want to benefit from the commercialization of 'their' IP.

Apart from complex licensing and royalty models, the most straightforward way for the university to participate in the spin-out's share capital is with shares. Therefore, when universities transfer or license IP to a spin-out, often a critical issue arises: How much equity should the university receive in return? This question is not just a matter of negotiation but a fundamental determinant of the spin-out's future success and often has considerable impact on the spin-out’s ability to successfully raise in the future. While universities rightfully seek to benefit from the commercialization of their research, excessive equity demands can lead to significant founder dilution and scaling issues, posing serious challenges for the fledgling company.

As a result, founders (who are often the driving force behind the innovation and growth of the spin-out) may find themselves with a diminished stake in their own venture which may lead to a lack of motivation and a reduced sense of ownership. A large equity stake for the university can also complicate future funding rounds, as investors may be wary of committing capital to a company where the founders conversely only hold a relatively small percentage of equity. Investors may perceive such a cap table as a risk, fearing that the founders might not be sufficiently incentivized to drive the company forward in the long term.

Eventually and in addition to these challenges, excessive founder dilution can also affect the governance and decision-making processes within the spin-out.

In the UK: The New Best Practice Recommendations for Equity Splits

A report published by Beauhurst in April 2024, which tracked 1,880 UK spin-outs since 2011, revealed that most UK universities have adopted a similar approach to equity distribution. This approach appears consistent regardless of the specific resource demands or IP-intensiveness of different types of spin-outs. While the mean figures show some variation, the medians are fairly close to the overall mean equity stake of 22.8% taken by UK universities. Specifically, life science spin-outs have the highest mean university stake at 24.1%, followed by software spin-outs at 23.1%, and hardware spin-outs at 21.4%. Such data indicates only modest variation in equity stakes based on the type of spin-out.

Over the last few years, founders and investors alike have criticized this approach taken by many UK universities. Especially compared to the situation in the US, founders considered their dilution to be excessive. They advocated for equity distribution models that consider the specific resource demands and IP-intensiveness of different spin-outs, rather than a one-size-fits-all approach. Universities should lower their equity stakes to ensure founders retain a significant ownership percentage, thereby maintaining their motivation and ability to attract investment. Finally, there was widespread consensus that clearer guidelines and transparent processes for determining equity stakes needed to be established.

This issue is particularly important to note when examining the success rates of university spin-outs. For instance, Oxford and Cambridge (two of UK's leading universities for spin-outs) demonstrate a stark contrast in how equity stakes affect outcomes. Between 2011 and 2021, Oxford created 193 spin-outs, whereas Cambridge created 137. However, Cambridge has been more successful in terms of acquisitions, with 36 % more spin-out exits than Oxford. One factor that may contribute to this difference is the average equity stake Cambridge takes, which is significantly lower (around 12.6 %) compared to Oxford's higher stake of 24.3 %.

In November 2023, the Department for Science, Innovation and Technology together with HM Treasury published a report by Prof. Irene Trancey and Doctor Abdrew Williamson for an "Independent Review of University Spin-out Companies". That review looked at the most successful university spin-out ecosystems across the world and within the UK, to identify potential best practices and opportunities to support spin-outs generate greater investment and grow faster in the UK. Amongst others, the final report proposed the following standardized equity splits for UK universities:

The proposed equity splits were intended to reflect the differing levels of investment, risk, and development time involved in spin-outs from the different sectors.

In the US: Smaller Stakes but they might come with a Twist

Compared to the UK, equity stakes for universities in the U.S. generally tend to be smaller, often in the low single digits, with some spin-out heavy-weights like MIT and Stanford typically taking around 5 %. Larger stakes are rare, particularly at leading universities. However, as always, one needs to look beyond the headline figure. We sometimes see U.S. universities asking for non-dilutive shares in spin-outs, even up to a series A funding round (according to a report published by Global University Venturing in July 2024, an approach taken by Stanford and others). In some cases, this means that the university's equity stake ends up being worth as much as if it had taken a large, double-digit chunk of equity before external investors come in (like their UK counterparts tend(ed) to do).

In Germany: Equity Stakes are Trending Downwards

Unfortunately, for Germany the available data is less comprehensive. Based on our experiences, German universities often take equity stakes similar to those seen of top U.S. universities (plus, they usually don’t come in the form of non-dilutive stakes).

• German universities take a larger stake (often in the range of 5 % to 10 %) when the spin-out is based on IP that provides a strong competitive advantage (especially patents).
• For IP with a more moderate impact (e.g., copyrights for software code), the university's stake falls often in the range of 2 % to 5 %, though smaller stakes are not uncommon.

However, the picture in Germany is more complex (when has it ever been easy here …), as German universities frequently have developed various offers that combine different license fee and purchase price models with different equity stakes.

But this menu approach comes with its own issues. The complexity of having various models can pose significant challenges for encouraging university spin-outs. Firstly, the lack of a standardized approach can create confusion and uncertainty for potential founders. Navigating through a maze of different models can be daunting and requires the (often first-time) founders to anticipate multiple future outcomes which can ultimately slow down the spin-out process. Secondly, the variability in models can make it difficult for investors to assess and compare opportunities across different spin-outs. Investors typically look for clear, straightforward investment opportunities where the terms are transparent and predictable. Any (perceived) complexity increases the diligence costs and potentially the investment risk. On the positive side, German universities' equity stakes are frequently dilutable which makes cap table considerations easier.

A Critical Moment for Germany's Spin-out Ecosystem

As we can see from the UK and the US, successful spin-outs tend to have low equity splits for universities, although the range varies by relevant sector and IP. Similar to the UK, U.S. universities have already made efforts to produce best practices for spin-outs.

Therefore, the key takeaway for German universities might be that while securing a fair stake in a spin-out is important, excessive equity demands can dilute the founder's stake too early, which could potentially hinder the spin-out's long-term growth and appeal to investors. A (non-dilution protected) stake of 2 - 7% (depending on the strength and relevance of the IP and maybe more in certain IP-intense life science cases) seems about right to us, provided that the other terms are fit for a spin-off. In particular, significant liquidity outflows in the form of minimum license fees can be a huge drag and it also does not make sense to delay the reckoning ("Why don’t we put it into the agreement now and then wait and see what the investor will think?"). Early-stage investors need to deploy capital quickly and don’t want to spend months on renegotiating terms on behalf of a potential portfolio company.

We feel strongly that Germany needs more university spin-outs, in fact way more and we need to speed up the spin-out process from currently often 6 – 12 months to 3 months max.

To achieve this, the universities and their transfer offices need support to navigate (perceived) legal challenges and feel confident that a negotiated outcome is actually fair. Most of them want to see their founders succeed and their IP getting turned into widely successful products (it is great marketing for the universities and attracts political support). In our experience, getting them access to robust data on multiple deal terms, not for traditional license deals with established corporations but for start-up deal making can go a long way. We know that higher education in Germany is widely left to the Federal States, but it seems obvious to us that everyone stands to benefit from a national register of spin-outs and the publication of deal terms in an anonymized format. In addition, let’s leverage experience and scale and come up with a streamlined template for spin-out term sheet akin to the U.S. University Startup Basic Outlicensing Template (US-BOLT) that has been co-developed by universities, investors and founders and gains adoption.

For a deeper dive into Germany's university spin-out landscape, see OLNS#10 (University Entrepreneurship & Spin-outs in Germany – Set-up / IP / Financing and Much More).

Regarding spin-outs from UK universities, check out our insightful Founder Series (Top Tips for University Spin-Outs - Part 1 and Part 2).