Licensing for Equity
Tom Hockaday, Managing Director, Isis Innovation Ltd
In the world of university technology transfer the opportunity can sometimes arise to license-out intellectual property rights in return for share equity in the licensee company, rather than the usual monetary consideration.
In variations of this situation, the licensee may offer share options rather than shares, the shares or options may be in a company related to the licensee company rather than the licensee-party company itself, and the shares may only be part of the overall consideration.
Our experience in Isis is that we have been offered shares as whole or part consideration on only a few occasions, usually when discussing licence terms with relatively young companies, often in the bioscience sector.
In the last ten years (as far back as ‘corporate memory’ stretches) we have never concluded a licence where any part of the licence consideration has been share equity. This paper discusses our reasons for taking this approach.
[Notes: To explain our use of terms: the TTO is that part of the university responsible for commercialising university owned intellectual property through the core activities of: attracting and assessing invention disclosures; patenting and other forms of intellectual property protection; licensing; spin-out company formation; material sales; managing seed funds. The TTO may also incorporate a function that helps researchers sell their time as expert consultants.
This paper relates to licensing out to existing companies, and does not specifically address the formation of new spin-outs. At Isis, when a new spin-out is formed there are two separate transactions: one, the university receives founder shares in return for enabling the spin-out and two, Isis licenses the Oxford IP in to the new company. This paper does apply to the licence to the spin-out but that is the not the primary focus.]
Reasons for current approach
The overwhelming reason for our approach is related to the question of who would control and manage the shares received in consideration for the licence. Some of the reasons are technical, some are practical.
It is normal practice for the university to have a procedure which describes how licensing income is shared out amongst three or four groups (i) individual researchers involved in a project (the inventors, contributors, beneficiaries) (ii) the University centrally, and (iii) the university department(s) where the inventors and contributors are based. The share to the TTO may be within the university’s central allocation, or explicitly stated as a fourth group.
This remains a straightforward distribution of cash, whilst the consideration for the licence is all in cash, made up of a combination of licensing fees, milestone payments and running royalties. The distribution may be complicated by revenue shares due to third parties; this may arise from the conditions attached to research funding or conditions attached to the assignment in of parts of the IP from third parties (e.g. co-inventors in other institutions).
If any of the consideration is in share equity a number of challenges arise:
Who is the legal owner of the shares?
The licensee company needs to enter a name on its shareholder register; is it the university, the TTO if incorporated as a separate company, the individuals? If the university or the incorporated TTO decides to receive them on behalf of the others, is it regulated by relevant financial services legislation to hold shares on behalf of other individuals; in other words are they regulated ‘stockbrokers’ who are able to hold other’s shares in nominee accounts or to take investment sale decisions on behalf of other individuals.
Who takes decisions associated with ownership (e.g. voting rights, rights issues)?
The shares are quite likely to be in early stage companies; shareholders are often involved in administration and decision making relating to the future growth and direction of the company.
Who decides when to sell the shares?
Even if the university or TTO could hold the shares, there remains the question of deciding when to sell the shares, in whole or part. The beneficiaries will include a number of individuals, the University centrally, the host Department(s) and possibly the TTO. The requirements for cash over time and the expectations of all these groups may well be very different. There is a well-known story in TTO circles of a professor suing his university for failing to sell stock at the top of the market; it barely matters that this may be apocryphal.
So, why not distribute them as they become due and are transferred across?
This is the most feasible possibility. It would require the co-operation of the licensee with the additional management and administration in issuing shares to all those involved rather than to one shareholder (this could be as many as ten new shareholders, a significant change to the shareholder register for a small company).
Far more challenging, it would require the value or price of the shares to be known, and accepted by those involved. This is because most universities have a royalty income distribution scheme by which the proportions received vary with total income received. If a university has a flat distribution scheme, this is not relevant.
For publicly quoted companies establishing the share value would be straightforward, but of course these are companies least likely to be offering equity for licensing in IP. For private companies the accepted basis for calculating the share value is the last price paid by investors; this may be an acceptable methodology which would need to be agreed by all in advance, but equally may not given the uncertainties of the timing and pricing of investment rounds in early stage companies.
Even if you work out a way to do it, or satisfy yourselves that these points are not a challenge for your situation, there remain a number of very practical, commercial points to consider. Independent of the technical reasons against taking shares, it is far from clear that accepting shares/options would be a good idea.
- Shares may be illiquid and having traded some cash consideration for share equity any beneficiary (inventor, university) may end up with an asset which is (i) unsellable or (ii) is worth less upon sale than the cash on offer.
- The cash considerations in a licence may well include upfront fees, milestones which generate cash for the beneficiaries relatively early. Shares are likely to be unsellable for quite some time, possibly delaying the time before the beneficiaries see any cash return.
- Conflicts of interest may arise from individuals benefiting from future share price increases. As a shareholder, the licensee may encourage the university, department head of inventors to put effort into supporting the company in ways which may increase the share price; for example providing unpaid consulting, agreeing favourable terms on research funding terms etc. This can be more challenging with options than shares, where any value at all is only realised at a future date, implying the need for additional effort up to that time.
- The university, department and technology transfer office would not receive cash which may be important to its ongoing operations and future business model. Risk is a key aspect here; generally universities and the people who work in them are risk averse; cash in hand may be more appealing than a share in the future.
- There may be tax issues relating to the transfer of shares (e.g. Stamp Duty) and the future management of the shares (dividend income and capital gains taxes) which mean the net cash you get from your shares is treated adversely compared to straightforward income.
- And remember - The value of your shares may go up as well as down.
You may by this stage be thinking, “hang on, live-a-little,” remember what we are here for – to transfer technologies out to business – the important thing is to find a way to get business investing in developing early stage university research outputs. There are a couple of points to consider along these lines:
- By owning shares in the licensee you may benefit as the overall value of the company grows in general; in this way you benefit in aspects of the company’s success independent of your university’s contribution.
- Shares may be the only way the licensee can make a payment at the start of the licence; it may be important for an early stage company to retain cash to invest in the development of technology.
Good luck! You can only hope that the shareholdings involved are sold at the top of the market, or that the individuals involved will be relaxed about the issues raised above.
And then of course there is probably a story out there somewhere about the deal where royalties were traded for shares and the shares turned out to be worth an absolute fortune, far more than any possible royalty could have been. A ‘Google’ for example.
Some university technology transfer offices in the UK, and no doubt elsewhere, have found ways to satisfy everyone involved that there is a legal, sound way to go about doing this (themselves, the university administration, heads of department, inventor beneficiaries).
There is a whole set of other considerations for a different but related scenario; this is the one where someone offers to buy-out the future revenues from an existing, large and promising royalty stream in return for shares in a listed company (or indeed for cash); one for the subject of another paper.
If a university technology transfer office is offered shares as part of the consideration for a licensing deal there are very good technical and practical reasons for not taking them.