Licensing Technologies from a University to Start a Company

Transcript

Stephen Thau:
Hi, I'm Stephen Thau. I'm a partner in our Technology Companies Group here at Orrick.

David Sharrow:
And I'm David Sharrow. I'm a partner in our Technology Transactions Group at Orrick.

Stephen:
And we're here today to talk a little bit about licensing technology from universities to start a company. And David, this is something that you and I have both done a fair amount of over our careers. We've worked with companies that were started from Stanford and UCSF and Harvard and various other illustrious institutions. And oftentimes, we're approached by a scientist, a faculty member, somebody at one of those institutions who's interested in starting a company. What are some of the things that you want to tell them at the beginning that they need to think about?

David:
Sure. No, absolutely. So I think the most important thing is that they communicate with their technology licensing office as much as possible to make them aware that they're interested in licensing the technology so that the university doesn't license it out from underneath them. But then the conversation very quickly changes to, well, how much is this going to cost? So in terms of royalties upfront, milestone payments, and the like. And from the university's perspective, they're often not as sophisticated as to a particular industry. So digging down into the type of medical device or pharmaceutical product or technology that's being licensed out will have a pretty significant impact on the royalty structure and the amount of royalties that are charged.

Stephen:
Right. And there are some standard aspects of a university license that I think people should come to expect. For example, almost every university says we want to be reimbursed for our patent expenses. Right. So if you're thinking about starting a company, just put that in your mind as part of the budget for the company formation is paying back the patent costs to the university. What are some of the other typical things that people should expect to be built into a license agreement?

David:
Sure. One of the things that's very critical to a lot of the universities is the diligence aspect of it. Because they want to make sure that this technology is actually going to be used, as that's one of the university's missions is to get the technology out into the world. And so having reasonable diligence milestones is something that's important to the university. However, unlike some commercial deals, they're willing to be a little more flexible than perhaps a private party would be. So my advice to a lot of founders is take your worst-case scenario and maybe multiply it by one or two. And that is probably something that the university will accept. Because they just want to understand that you're working at a pace, but they understand that technical difficulties arise. Another aspect to bear in mind is that very often these are very early technologies. And the patent portfolio may change over time. And the patent landscape may change over time. So making sure that you have sufficient rights from the university. And add in what's called a royalty stacking provision because you may need to license technology from other institutions or third parties as well. And you want to make sure that your entire royalty payment doesn't still mean--

Stephen:
Right. These things can grow.

David:
They can grow. It still has to be a commercial business. Absolutely.

Stephen:
Yeah, no, that's absolutely true. And oftentimes you'll see milestone payments. Especially in the biotechnology space or the medical device space, as a product moves through the development cycle, critical trial milestones, first commercial sale milestones, hitting sales certain targets, royalty rates. Right. All that is to be expected. What about the right for-- if you're licensing technology for a company, oftentimes the business plan of that company will be then to license it to another company. How do sub-licensing rights come into play?

David:
So sub-licensing rights come into play in that universities need to know who their sub-licensees are. And it's an aspect where you need to make sure that you can sub-license through multiple tiers of different levels in the chain. And you also want to make sure that there are certain types of sub-licensees that may be excluded, such as distributors and wholesalers, so that you're not paying 20% or 30% sales sub-license fees on the amounts they're received from those folks. So I think that making sure that you've got the sub-licensing right and understanding exactly what that entails in terms of reporting back to the university and getting university approval is pretty critical.

Stephen:
Yeah. And the other thing that I always see, especially these days, almost always-- some exceptions-- but almost always, a university will ask for a percentage of the equity of the company.

David:
Yes. And that's something that's probably more in your realm.

Stephen:
Yeah. And something-- yeah. This comes up all the time. And we've seen recently universities getting a little bit more aggressive in terms of their ask. And so there's always a negotiation around the number, what percent-- is it 5% of the company? Is it 10% of the company?

David:
Right.

Stephen:
And then also, when you measure that percentage. And universities oftentimes will ask for what they call anti-dilution protection. And that's a little bit different from when investors ask for anti-dilution protection. In a Series A term sheet where you see anti-dilution protection is usually price-based. It means that if the company later sells stock at a lower price, something happens to the investor shares that is beneficial to the investors. When the universities talk about anti-dilution protection, they just mean, no, we get more shares. Up to a certain point. And so negotiating that point, understanding how those calculations work, is a really important part of the negotiation. And it's not in isolation, because that's part of an overall economic package that relates also to the other payments they get. So would you see universities trading royalty rates for equity and milestones?

David:
I often do. At one point, I conducted a survey of about 100 license agreements. And there was a bell curve that showed how the royalty rate and the equity rate interacted. And I think that's probably a little out of date now. But the relationship still does hold that if you were willing to give up additional equity early on that you can often negotiate a lower royalty rate. And I guess one other question on the equity is that, unlike investors, universities don't expect to pay for that equity, at least not up front.

Stephen:
That's absolutely true. And so it goes to the type of equity also. And oftentimes, it's common stock as opposed to preferred stock that investors would get. But then universities will also often ask for the right to participate in future rounds. So when the company raises more money and sells stock to investors for the university to have the right, if they own x% of the company, the right to buy x% of the future round. And from time to time, you see universities exercise that right and write checks to companies for cash to buy stock. But that's a future round. That's not the initial formation of the company. University view on formation is no, that's for the IP that you're getting from the university.

David:
And what about other investor rights? Do they often get rights that VC investors would get, such as board participation?

Stephen:
Yeah, seldom. I would say board participation, like board membership, being an actual member of the board, is relatively rare. But sometimes more frequently, you see the request to have board observer rights, especially at the early stage when the university technology office feels a little bit more aligned and affiliated with the launching of the company. They may want early stage board observation rights. So you see that from time to time. And generally, it's not objectionable. Sometimes people are worried, like, what does this mean? And usually it's not a problem.

David:
And what about the rights of universities on exits? Do they ask for transfer fees or--in addition to their equity.

Stephen:
Yeah, yeah. You mean double dipping?

David:
Yes, yes.

Stephen:
No, they will sometimes ask to double dip. And you'll say, well, wait a minute. You already own x% of the company. And now you're saying when the company is sold, you want to get a cash payment for y dollars. And that y dollars is sort of independent of the value of the company. And it's sort of a transfer fee. And my thought is it's part of that whole economic package. And it would be interesting to look at where that sits in your bell curve analysis. But yeah, that comes up. And from a company point of view, you want to minimize that as much as possible and make it easier to sell the company with fewer strings and fewer different payment streams going out to different folks. But ultimately, investors can digest those terms and just factor that into their models. So it's just another thing to consider.

David:
Absolutely.

Stephen:
What about know-how? There's a topic that comes up a lot. That comes up a lot. When you're dealing with patents, it's pretty clear what's covered by the patent, or at least with reasonable certainty, you can read the patent claims. Know-how is a little bit fuzzier.

David:
Yes, know-how is definitely a little fuzzier. And universities often try and get that in the mix so that if the patents don't issue or if the patents expire or are not applied for in certain jurisdictions, they still get their know-how royalty rate. And that's often around 50% of the overall royalty rate. Trying to nail down universities as to exactly what that know-how is, is virtually, it's difficult to do. But they say, look, we're a university, and we can't track it. But you have received benefit from the fact that you were participating in this lab. So we deserve to recoup our costs that are involved. So that is a hot topic. And many times, if it's very nascent technology, you may be able to say, we don't want it. We don't need it. We just need the rights under the patent to move forward.

Stephen:
Yeah. No, it's an interesting-- that would be an interesting tactic to try. Some circumstances, I can see where it would work. And sometimes it's harder.

David:
It's harder if it's coming out of the founder's lab, for sure.

Stephen:
Yeah. Yeah. Certainly. Well, great. Well, this has been a terrific conversation. Thank you.

David:
Absolutely.

Stephen:
And I hope this was useful for folks in the audience.