University Technology Transfer - Share Equity Dilution, or "When 50 = 5"
I hope that governments and other commentators will come to understand about dilution and anti-dilution of shares in university spin-out companies. Or, to put it another way: when does 50% = 5%?
A number of universities in the UK take the approach of having the same number of shares as the founding researchers have in a new spin-out company. As the university and the founder researchers are the first two categories of shareholder this is often referred to as 50:50; this is a ratio. The spin-out company then seeks financial investors who buy more shares in the company, and attracts leadership and management who also typically become shareholders. Let’s say the university started out with 1000 shares, which represented 50% of the company; after investment and management the university still has 1000 shares, but these now represent let’s say 30% of the ownership of the company. This change in percentage ownership is called ‘dilution’. Another couple of investment rounds later and the university may find itself still holding 1000 shares, now representing 5%. Then lets say there’s an exit opportunity and the university chooses to sell its 1000 shares / 5%.
In other cases, a number of other universities take the approach of starting out with a 5% shareholding, and ending up, a number of investment rounds later, still with 5% because the 5% they start with are special shares with special contractual protection against dilution, otherwise known as ‘anti-dilution’ provisions. The initial 5% stays at 5% because each time new shareholders come in the university gets more shares as well without paying extra for them (there are other ways of structuring this for the same outcome). So, a university may start out with let’s say 100 anti-dilution, protected shares, and end up with 1000 shares. Then lets say there’s an exit opportunity and the university chooses to sell its 1000 shares / 5%.
This is how 50% with dilution ends up the same as 5% without dilution. It is really important and not that difficult to understand the difference.
To some extent this is a transatlantic difference. In the US, many universities are located in innovation communities of such dynamism that the TTO (often called Technology Licensing Office in the US which further highlights the point) involvement is limited to issuing an IP licence to ready-made teams of founders/investors/entrepreneurs. In some cases, the university wants a decent return from the spin-outs and so wants 5% for when the company is sold or floats. In the most dynamic communities in the world (see California, Boston), a university may be able to afford an approach where it is comfortable with 5% far earlier in a company’s growth. Investors are really keen on promoting this approach; but then, they are not the only ones involved.
In the UK, university TTO’s have grown up to be far more involved in supporting researchers in setting up spin-out companies: writing business plans, finding investors, finding entrepreneurial managers, building the team, supporting the company. In even the most dynamic UK innovation communities it is very, very unusual for a fully formed, competent and capable team to come along and ask for a licence to university IP.
There is quite a lot of debate in the UK at the moment about the best approach for a university to take in terms of the initial shareholding in the spin-outs that are based on the university’s intellectual property and the work of the researchers employed at the university. A closely related point is the terms under which the university’s intellectual property is licensed in to the new company, providing the platform for the company and the investors to grow value. A further related point is the extent to which the university has an active programme for follow-on investments in its own spin-outs, so that it can maintain and grow its shareholding in the spin-outs it believes will be most successful.
I have written before that universities should be ‘as generous as they can afford to be’ in terms of setting their approach to spin-out founding shareholdings and to licensing terms. Universities are very good at explaining how they are striving for maximum impact, not cash, from their commercialisation activities. They are less clear on deciding how they will pay for the technology transfer activities that help to generate the potential future impacts they are so keen to promote. The challenge is for a university to know how generous it can afford and wants to be.
Tom Hockaday
April 2016
A number of universities in the UK take the approach of having the same number of shares as the founding researchers have in a new spin-out company. As the university and the founder researchers are the first two categories of shareholder this is often referred to as 50:50; this is a ratio. The spin-out company then seeks financial investors who buy more shares in the company, and attracts leadership and management who also typically become shareholders. Let’s say the university started out with 1000 shares, which represented 50% of the company; after investment and management the university still has 1000 shares, but these now represent let’s say 30% of the ownership of the company. This change in percentage ownership is called ‘dilution’. Another couple of investment rounds later and the university may find itself still holding 1000 shares, now representing 5%. Then lets say there’s an exit opportunity and the university chooses to sell its 1000 shares / 5%.
In other cases, a number of other universities take the approach of starting out with a 5% shareholding, and ending up, a number of investment rounds later, still with 5% because the 5% they start with are special shares with special contractual protection against dilution, otherwise known as ‘anti-dilution’ provisions. The initial 5% stays at 5% because each time new shareholders come in the university gets more shares as well without paying extra for them (there are other ways of structuring this for the same outcome). So, a university may start out with let’s say 100 anti-dilution, protected shares, and end up with 1000 shares. Then lets say there’s an exit opportunity and the university chooses to sell its 1000 shares / 5%.
This is how 50% with dilution ends up the same as 5% without dilution. It is really important and not that difficult to understand the difference.
To some extent this is a transatlantic difference. In the US, many universities are located in innovation communities of such dynamism that the TTO (often called Technology Licensing Office in the US which further highlights the point) involvement is limited to issuing an IP licence to ready-made teams of founders/investors/entrepreneurs. In some cases, the university wants a decent return from the spin-outs and so wants 5% for when the company is sold or floats. In the most dynamic communities in the world (see California, Boston), a university may be able to afford an approach where it is comfortable with 5% far earlier in a company’s growth. Investors are really keen on promoting this approach; but then, they are not the only ones involved.
In the UK, university TTO’s have grown up to be far more involved in supporting researchers in setting up spin-out companies: writing business plans, finding investors, finding entrepreneurial managers, building the team, supporting the company. In even the most dynamic UK innovation communities it is very, very unusual for a fully formed, competent and capable team to come along and ask for a licence to university IP.
There is quite a lot of debate in the UK at the moment about the best approach for a university to take in terms of the initial shareholding in the spin-outs that are based on the university’s intellectual property and the work of the researchers employed at the university. A closely related point is the terms under which the university’s intellectual property is licensed in to the new company, providing the platform for the company and the investors to grow value. A further related point is the extent to which the university has an active programme for follow-on investments in its own spin-outs, so that it can maintain and grow its shareholding in the spin-outs it believes will be most successful.
I have written before that universities should be ‘as generous as they can afford to be’ in terms of setting their approach to spin-out founding shareholdings and to licensing terms. Universities are very good at explaining how they are striving for maximum impact, not cash, from their commercialisation activities. They are less clear on deciding how they will pay for the technology transfer activities that help to generate the potential future impacts they are so keen to promote. The challenge is for a university to know how generous it can afford and wants to be.
Tom Hockaday
April 2016