Tactics for Controlling Equity Dilution in University Startups

July 20, 2011

Today’s Agenda

• Who Owns University IP

• University Spinout Creation

• Protecting the University from Future Dilution

• Key Licensing Terms that Impact Financing

• Protecting Founders from Dilution

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Who Owns University IP

Inventors that universities care about:

Undergrads – NO (usually)

Faculty, Staff and PhD students - YES

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Who Owns University IPJust like a corporation, universities own the

IP created by its employees

•Do not assume altered by Stanford v. Roche US SCt ruling–Bizarre set of facts and

bizarre ruling–University will just be more careful with language in

employment documents

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Who Owns University IPNormal process is disclosure by

inventor to TTO•TTO not obligated to file patents, but often does at its own expense• Inventor is compensated

–Typical is 1/3 Department, 1/3 TTO, 1/3 Inventor–Applies to license fees, royalties, equity value–Each university has its own written policies re $$ split

•Some would argue that compensation is very attractive incentive for inventor

–Remicade (NYU); Emtriva (Emory); Lyrica (Northwestern)

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University Spinout Creation

University has 2 routes for a technology

License to spinout

License to established company

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University Spinout Creation

University has 2 routes for a technology

License to startup (spinout)

License to established company

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University Spinout Creation

And these are very different licensing paths as far as the university is concerned

• With established company license, deal is cut and papered and University collects $ and audits

• With startup company license, TTO needs to vet the company, make sure that a market exists, make sure a business model exists and generally get confident in the startup team– Sounds like a VC (but not)

• Under a given set of circumstances either route may be preferred (often land grant university is more focused on startups and economic development)

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University Spinout CreationSo, does the university care

about the startup team?• How can faculty participate?

• Is a PhD involved?

• Who is CEO running the show?

• What are university conflict policies?

• Is the startup in a university incubator?

• WHEN can the company pay for patent costs?

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University Spinout Creation

Critically, how are conflicts handled?• Can faculty be “officer” of startup?

• Can startup use university facilities?

• Can startup use the faculty member’s research lab?

• Are PhD’s co-mingled with startup?

• Does university have a claim to new IP developed at startup? The so called “grab” issue……

• Can startup fund research in inventor’s lab?

• And, who is the JUDGE?

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University Spinout Creation

The Judge• Many schools have conflicts policies that look very

similar

• It is the implementation that varies

• It is the culture that varies

• It is the “old guard” vs “new guard” that varies

• Is the judge the department chair or college dean or TTO administrator?

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University Spinout CreationReality is that judges

come in different flavors

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Protecting the University from Future Dilution

Universities take equity stake in

startup as part of license deal

• Dilution should be hoped for!

• Dilution should be expected

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Protecting the University from Future Dilution

But some protection is ok in early years

• Example 1: no dilution until after $X raised– Early funders should not care– Founders take it “on the chin”– Keep it simple

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Protecting the University from Future Dilution

But some protection is ok in early years• Example 2: University can invest going forward• Most do not (Stanford and MIT are exceptions,

but MIT only exercised 2 times)• Many top research universities have “sold” their

preemptive rights to Osage Ventures• Carnegie Mellon actually has taken equity for

patenting costs

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Protecting the University from Future Dilution

But some protection is ok in early years

• Example 3: The UNC simple license model– Received much attention in press and pubs– UNC set terms for 1% royalty and 1% carve

out on change of control– Carve is 100% non-dilutable

b/c not an equity stake

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Protecting the University from Future Dilution

But some protection is ok in early years

• Example 4: Convertible debt model for initial slug– Equity slug not valued until qualified round

occurs– So university equity valued off that round price

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