Tips and traps for university start-ups

It’s not always easy for university start-ups to get all their ducks in a row – many never even get past Go.

With years of experience working on university start-up transactions (across both the university and advisor side) we understand the foundations needed to set up for success as well as the ramifications of not getting it quite right.

Aspen Legal director, Joseph McCarthy sets out 5 key tips for start-ups in the higher education sector below:

1. Complete due diligence on the IP and lock it down

It’s crucial to confirm that the university owns or controls all IP rights in the content that it wants to commercialise. The origins of the IP must be understood and the researchers must be requisitioned about this (and, if necessary, formally assign their interest in the IP to the university). If this isn’t done, the university may be exposed to others claiming they own part of the relevant IP, leading to future embarrassment (at the very least) for the university and potential breach of its IP ownership warranties.

Investors in a university spin-out won’t proceed unless they receive water-tight warranties that the IP is completely owned or controlled by the spin-out company (or university if the IP is licensed by the university to the spin-out) so this due diligence is both unavoidable and extremely valuable as key-risk mitigator.

2. Agree on a commercialisation pathway

It’s important to clearly define the commercialisation pathway, including:

• Development stage gates
• Cost and time runway
• Indispensable tech and subject matter expert inputs
• Minimum Viable Product (MVP)
• Total Addressable Market (TAM)
• Revenue model unit economics

The right pathway could, at its simplest, be a licensing deal that earns the university royalty payments, or range in increasing complexity all the way through to the university growing a business around the IP by transferring it to a spin-out company that is partly owned by the university, and helping the spin-out raise capital to fund growth.

Commercialisation of IP depends entirely on its profile (eg. is it productisable or does it lend itself more to being a service? Is it engineering kit or comprised solely of software?) and it is necessary to understand the costs and time that will be required to develop the IP into a product or service, the potential fees that customers will pay to use or buy it, the total size of that market, and whether the marketing and sales channels will need to be built from scratch or via a new alliance or partnership with an existing industry player.

Understanding these things will shape the setting of commercialisation goals that act as natural junctures for when the company will need more funding (particularly when it is pre-revenue and can’t fund itself).

“University start-ups thrive when IP is secured early, commercial goals are clear, and incentives are aligned to keep founders and investors committed.”

3. Curiosity

Taking a birds-eye view of the deal is crucial, with key considerations including:

• Is the university just licensing the IP to a spin-out NewCo (with an option for NewCo to own the licensed IP when it hits commercialisation milestones)?
  If setting milestones, these need to be realistic and achievable for the company and also serve as indicators of the company hitting critical development points where it can operate independently of the university and have a chance of surviving and flourishing. If unrealistic milestones are set, the company’s management team can get deflated if they fall short, and motivation and commitment can wane as a result.
  
• Is the university also investing cash into NewCo?
  If so, is the cash coming from an internal university investment fund operated by a team that sits separately from the commercialisation / research team that built and packaged-up the IP? If so, be careful to avoid conflicts and know which senior executive you can escalate to if instructions between these two teams diverge.
  
• Will NewCo reverse-engage the university under a research services agreement to further develop the IP?
  The university can benefit from the spin-out paying funds back to the university in exchange for the university undertaking further R&D on the licensed IP, and these funds can be claimed as research income for the university’s reporting purposes. Again, avoid conflicting instructions from individuals wearing multiple hats (eg. a researcher instructing you on behalf of the university regarding terms and conditions in the Research Agreement, but who is also a director / shareholder of the spin-out company on the other side that same Research Agreement).
  
• Are third party investors / VC simultaneously investing in NewCo alongside the university?
  If so, who is investing more, and does the other investor assume that they will be the lead investor for the round, and expect the university to accept the investment terms that the lead investor has secured for itself. Multiple investments made by several different investors concurrently, if they can be co-ordinated, can be executed simultaneously using the same Term Sheet and investment documents, eg. Share Subscription Agreement and Shareholders Agreement (which saves the university money if it can “piggy-back” on the other investor’s documentation).
  
• What’s the kick-off Cap Table?
  Who gets ground floor sweat equity and board representation? Who gets control over key decisions (including follow-on and exit rights)? The university needs to protect its investment by ensuring that, if possible, it has a say (at both board and shareholder level) in key decisions that affect the prospects of the company and the university’s ability to monitor the company’s performance.

4. Focus on your Term Sheet

Your Term Sheet is a key document that brings everything together and is the basis for lawyers drafting long form transaction documents. The more that gets ironed-out at Term Sheet stage, the less scope for protracted negotiation and disagreement when it comes time for drafting the documents – which means reduced costs in the long run.

“Missed details in IP ownership, unclear pathways, or misaligned equity can derail a university spin-out—careful planning at every stage is essential for long-term success.”

5. Incentivise participation

It’s critical that everyone involved is incentivised to participate, and that these incentives are in overall alignment when viewed as a whole. It’s common that researchers, as founders of the spin-out, may need to be given shares in the company from the outset to motivate them to work hard and contribute to the company’s success over time. They can be given those shares subject to a vesting regime (where the shares “vest” in their name over time rather than up-front in one go), to lock them in for longer and increase retention of talent. Universities shouldn’t take too much ground floor equity, as this might scare off later stage investors (who themselves should typically only ever be offered up to 10-20% of the overall shares during capital raise rounds). If either the university or early-stage investors grab too much equity in the early phase of the company, the founders (who need to stay motivated) will be diluted too heavily as the company grows and takes on more investors.

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Aspen Legal is a commercial law firm and legal secondments business with significant experience in the tertiary education sector. Our lawyers have created and led teams in-house at globally ranked universities and currently partner with some of Australia’s top institutions in an advisor capacity. With plenty of university start-up transactions under our belt, we can help guide you through the entire transaction roadmap.

Keen to know more? Get in touch with our team of experts.