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Tomas Ulrichsen, Zoi Roupakia, and Leonard Kelleher

A policy debate on spinouts dominated by issues on equity

There is currently an intense debate amongst policymakers and others focused on understanding how best to strengthen the ability of the UK’s research and entrepreneurial innovation systems to produce more, high potential university spinouts able to unlock new sources of economic wealth and industrial competitiveness.

Recent discussions on how to improve the system have been dominated by a singular focus on the level of equity universities take in their spinouts, and whether this is conducive to spinout success and the ability of companies to raise external financing to drive their development and growth. Our report shows that this is misplaced, with claims typically levied at universities often misleading or overly simplistic.

The discussions also come at a time when we have seen significant growth and positive developments in the UK spinout landscape. Over the past decade, the number of spinout deals has doubled and the amount of investment raised by UK spinouts increased from £970 million to over £2.9 billion in 2019/20. Since 2013, the universities of Oxford, Cambridge, UCL and most recently Manchester, Leeds and Sheffield through Northern Gritstone have raised over £1.7 billion in capital dedicated to investing in their spinouts. This reflects a growing investment by many research universities in their system of support to help academic founders develop their ideas and technologies towards commercial application and assemble a commercially attractive business proposition able to attract investors.

But, as a major review of UK university-investor links in 2019 by Mike Rees (the former Deputy Group CEO of Standard Chartered) found, while the UK system is certainly not broken, as with all systems, it can always be improved and strengthened.

Differentiated approaches to equity

Our report shows that the approaches of many universities to taking equity have evolved over the past decade reflecting changing conditions and preferences. Many have now developed approaches that seek different levels of equity based on the type of intellectual property (IP) being commercialised by the spinout, the amount of support (in-kind and increasingly financial) provided to the spinout, and any financial terms of the IP license.

Contrary to popular perceptions, the level of founding equity typically taken by universities is much less than often claimed, with the median founding share is 33% where the spinout is built around IP generated at the university and investment (in-kind and increasingly financial) of support to develop the company prior to foundation. This equity is typically fully dilutable as investors enter the spinout. Furthermore, pools of equity agreed between the academic founders and the university to incentivise an incoming CEO or employees typically dilute the initial shareholdings of both the founders and the university in proportion. This means that, even before any investment enters the spinout, these equity pools immediately reduce the median university founding equity share to 20%.

Where spinouts are based on know-how or little formal IP from the university or have received little support the median university founding equity pre-money is 10%, reducing to 5% once pre-agreed equity pools are accounted for.

Many commentators also frequently compare the UK university system with the approaches of Stanford University and MIT in the US, two specific universities based in very particular dynamic and entrepreneurial clusters, to justify the UK pursuing a low-equity approach. We suggest this can be highly misleading if we only focus on the founding equity figure. These universities do indeed take up to 5-10% equity in their spinouts, but this equity typically comes with anti-dilution clauses that prevent their shareholdings from becoming diluted (often until a certain investment threshold). Crucially, the IP is often licensed into the spinout with terms negotiated at arms-length and on fully commercial terms, i.e. as if the spinout was any other private corporation.

In the UK, a university’s founding equity, while higher than that of Stanford and MIT, will typically fully dilute alongside other founding shareholders. If they cannot co-invest as the spinout grows, their initial stake typically will often be is diluted down to low single digits once the company scales up and successfully exits.

Furthermore, in many cases where higher levels of equity are taken, deals are typically accompanied by royalty-free licenses or a license with more favourable terms than would be the case if negotiated as a fully commercial transaction. In balancing equity with licensing terms in this way, the ambition of many university TTOs is to keep as much cash in the spinout as possible during its infancy when cash flow is critical.

Beyond equity: the many barriers to spinning out ventures to commercialise university research

As policymakers and others look to review how they can act to turbocharge the UK research and entrepreneurial innovation system to produce more high-potential spinouts to unlock new sources of economic wealth and drive national competitiveness, it is crucial they urgently move beyond the singular focus on equity distribution between founders. While deal terms can be difficult to negotiate – as would be typical in any complex commercial transaction – our report captures the views of Technology Transfer Directors on the much wider range of barriers that hamper the production and early development of spinouts in the UK. Other barriers include, among other things:

• The ability to de-risk technologies and the venture sufficiently before incorporating and having to seek investors
• The time availability, motivation, and entrepreneurial capabilities of academic founders
• The ability to find sufficient talent and expertise in their local economies and access the necessary facilities and equipment to further development
• The strength of the investment environment readily accessible to the university and founding teams
• The availability of sufficient resources within universities to meet increasing demand from academics seeking to commercialise research

Moving forward

As we look to the future, we need to build on the significant successes of the past decade in growing the UK spinout ecosystem. But we can always improve and do more. Given the increasingly turbulent times we live in, we must nurture a system that is able to evolve and adapt to rapidly reflect changing opportunities, conditions, threats and preferences. To do this, we urgently need to move the debate on from its singular focus on the distribution of equity at the point of spinout foundation. Negotiating equity can be challenging, but it is often resolvable. Other critical barriers are much more structural and harder to overcome.

We need to find practical solutions to key challenges. A productive way forward would be to assemble a ‘coalition of the willing’, drawing from different parts of the spinout landscape, and dedicated to building collaborative and constructive dialogues aimed at solving the most important structural and persistent barriers holding the system back. We can draw on inspiration from similar initiatives elsewhere, for example the US-based University-Industry Demonstration Partnership that brings together universities and large companies to solve problems affecting research and innovation partnerships and find ways of unlocking new sources of value.

Such a group work to pinpoint where key problems exist and work collaboratively to find pragmatic ways of alleviating them, with a goal of strengthening the UK spinout ecosystem. In doing so we must adopt an approach that accounts for both the research-to-innovation lifecycle of the spinout process and the systems nature of the problem. Crucially, we need to involve the full range of individuals and organisations that invest their time, effort, and increasingly money, to not just help specific spinouts progress towards commercial success, but also to build and nurture the entrepreneurial innovation system that underpins this journey.

We know this approach can work. Let’s come together to make it work in the UK.

Tomas Ulrichsen is the Director of the Policy Evidence Unit for University Commercialisation and Innovation (UCI) at the University of Cambridge. Zoi Roupakia is a Research Associate at UCI. The views expressed in this news item and in the report are of the authors alone and should not be taken to represent the positions of any organisation with which they are affiliated.