What to Expect When You’re Spinning Out a Deep Tech
At Pillar and Petri, half of our investments are in companies that spin out of universities. We’ve collected our lessons learned and created a step-by-step timeline. If you are at an academic lab, this will help you know what to expect when you spin out your deep tech.
One of the key steps is licensing.
Why would you need a license to develop your own invention in your own company? If you are currently a PhD student, Faculty member, or a postdoc, you are an employee of the university. If you look back at your employment agreement, the university will likely own the intellectual property that you create while on campus, especially if it is related to your area of research or if you made the invention through the use of university resources.
Most universities set up a department to handle patents, and this will be staffed by licensing officers. They keep an eye on the research happening across the university, and they decide when an invention is worth patenting. If the invention has commercial value, they are responsible for arranging the business deal for a license. In some cases the licenses go to large corporations, but if you are an inventor who wants to commercialize your own invention, and if you have a good business plan as explained below, most universities will be glad to give you the license in return for a royalty.
Licenses can take 3-6 months to complete. Follow the following timeline for your licensing negotiations:
Confirm licensing office is open in principle to license (2 weeks)
If you are not running your own lab, start by checking with your Principal Investigator (PI). While it is rare that a PI wouldn’t be agreeable, their support is critical in making sure your university licensing process runs smoothly.
Don’t let your PI be surprised by your visit to the licensing office to start discussions.
If PIs have experience in spinning out technology, they will have their own expectations of how things should go. But if they don’t, you might encourage them to speak with an experienced colleague they trust to learn more.
When your PI is on-board with the decision, begin conversations with the licensing officer who is in charge of tracking your area of work. Find out what their process looks like and what they will need to see from you in order to grant a license.
Before they would give you exclusive rights on a valuable license, most licensing officers will want to know you stand a good chance of success at commercialization. So they will likely ask for your business plan and for your plan to raise capital.
By checking early, you can confirm that the licensing office is supportive before you continue to work on the business.
Work with your team on the plan (2-4 months)
For the next few months, work with your co-founder or team to deeply understand the needs of customers, the commercial requirements, the realistic potential for commercialization of your technology to hit those requirements, and the steps required to build a product and then a company. This information will shape your business plan.
Doing this work builds value for your company and usually does not require much cash. It does require a lot of listening, networking, and planning.
Much of the work here is similar to what you might be building for your investor pitch deck, if you plan on raising money from VCs.
Areas to assess:
Customer Listening. Who is your customer and problem will you solve for them?
Product Roadmap. What types of products will the company plan to create?
Technical Diligence. Does the technology work well enough for these commercial uses?
Business Model. Will the product be profitable?
Market Size. How big is the market we’re tackling?
Competition. Are there other competing technologies or companies that may have IP or relevant products in the same space?
Financials. How much cash will you need to launch your product? When will the company generate enough revenue to breakeven, and how much cash will you need to get there?
Team. What skill sets do you need on the founder team, and who else will you need to hire in the first few months?
Ideally, the license will match the needs of your business, and the royalty formula will be a fit with your business model. So be sure to put time and energy into making sure your plan accurately represents your plan for the future.
At this point, you may check in with the licensing office to review your progress. If all goes well, you’ll look to receive a verbal agreement that the licensing officer intends to work with you to negotiate a license or license option.
If you foresee this process stretching out for a while, consider asking the license officer for an option. This will give you a guaranteed right to license the technology for a period of time (generally 6 months to a year). You can do a great job at all the work above and remain confident that the license will not be granted to someone else in the meantime. For our Petri cohorts, this has been the route they’ve taken when spinning out, more often than not.
Agree on founder splits, incorporate, start fund-raising (2-4 months)
Once you are convinced you have a great business plan, and you know you have access to the license, you may be ready to move ahead. It’s time to start the business.
Founder Splits. The best time to divide equity is right at the beginning, when everyone is in a good mood and there is no significant value.
Edison said genius is “2% inspiration and 98% perspiration” and the same is true for building companies. Although a university invention may be brilliant, it is generally raw. The vast bulk of the effort and many of the thorny technical challenges still lie ahead. That is why the majority of the equity needs to go to the management and employees.
How do you balance that in a fair way?
If all the inventors leave and they are the only founders, then of course they will own 100% of the founder’s shares. But what if there is a grad student who does not join, or a Professor who will only consult on the side, or a professional business person coming in as CEO or VP? How do you divide the value awarded for technical invention vs. the value for future company-building?
Consider using a 20-80 framework. Up to 20% of the company is set aside just for “creators”, and the remaining 80% is reserved for future management and employees in return for building a successful company.
The 20% level is a guideline that can be varied to fit the situation, and should take into account whether the invention is close to commercialization. But let’s continue with that example.
Of the 20% for the creators, this should be allocated partially in recognition of past contribution but mostly according to each founder’s ability to help the idea overcome future thorny technical challenges.
How should stock be divided between Professors and postdocs?
We see two situations: (1) a Professor drove the invention and closely directed the work, where the Professor may get half the creator column and the rest of the team shares the rest; and (2) the Professor played a key role in setting up the lab and providing only guidance, but the grad students really drove the specific invention. In that case giving the Professor an equal amount as each grad student will make more sense.
Of the 80% for management and employees, a good rule of thumb is that an experienced CEO would receive one-third, the Vice Presidents would together receive one-third, and the final one-third would be shared among the team, with the majority going to the senior employees such as architects or principal scientists, and the remainder split among the junior hires.
Management and Employees (80%)
Key Grad Student 1 (3-6%)
Key Grad Student 2 (3-6%)
6-10 Key People (18.66%)
10-20 Junior People (8%)
What if a graduate student is both a creator and will be joining the company as an employee? That student would participate with a share from both columns. Thus if a grad student with 6% were also joining as VP Research for 8%, he or she would own 14%, which could be more than the Professor.
These Percents Frequently Change, So Focus on the Ratios Among Founders. When you first start the business, the future hires will not yet be part of the company, and their shares may not yet exist. So all of the percentages above will look like bigger percentages of a small number of shares.
Later, as the company raises capital, there will be dilution for ALL of the founders and employees. Suddenly all of the percentages in the table above will look smaller.
Therefore you should not concentrate on any particular percentage target.
Focus on how the pie is divided among founders and employees by looking at ratios. For example, should one founder get twice as much as another?
This ratio will remain fixed as the company raises capital as both parties dilute together. Therefore, looking at relative proportions is the key to deciding whether you have fairness across the team.
Vesting. Founder’s shares will “vest” – meaning that you only get to keep it if you stay in your job long enough to earn it.
Why does vesting make sense even for the founders? This protects everyone. Fighting could lead one of the founders to depart. Even if the chemistry works, founders may leave unexpectedly. Sometimes founders have personal problems such as medical issues, depression, family distraction, moving spouse, or an aging parent. Sometimes the business just evolves away from the expertise of a founder and they become unnecessary and agree to leave. Vesting ensures that if a founder with a lot of stock unexpectedly leaves, the company will get back enough shares to hire an equally awesome replacement.
If a founder with a lot of stock unexpectedly leaves, vesting ensures the the company will get back enough shares to hire someone new.
Founder’s stock and options usually vest over four years. The first 25% vests at your one-year anniversary at the company, and not before. That protects the company from making small stock awards to people who only work for a short time at the company. After that threshold is reached, the remainder vests quarterly over the final three years, at 6.25% per quarter.
All of these stock arrangements must be in place right from the start. Ask your corporate attorney to create a stock option plan, a draft offer letter, and minutes after each board meeting to approve each option grant to keep all this in good order.
When to Incorporate. Work on these documents and get them ready in advance, because they often take several months to negotiate. That is especially true in deep tech startups, where there could be a lot of founders.
The time to incorporate is after (1) you know you have a valid idea; (2) you have a clear plan and budget in view; (3) the people around the table have cash or savings to fund at least the walking around costs; and (4) the founders understand how they will divide the equity. If you are working with a licensed technology then you should also have (5) a verbal agreement that the licensing officer intends to work with you to negotiate a license or license option.
Incorporation typically takes
so manage accordingly.
Incorporation can be done in a matter of a week or two, however, it may take more time while you come to a meeting of the minds. In most cases it takes 3-6 months, so manage accordingly.
If you’re curious what type of company to incorporate as, your lawyer will likely give you the best, most specific advice, though we generally recommend a Delaware C-corp.
Everyone should stay employed with the university right up until the moment you sign your founder agreement. The founder agreement requires you to assign your inventions to the start-up, and since your current role likely requires that you assign any IP to your university, you would have a conflict to hold both positions at the same time.
Some academics try to moonlight by creating their own inventions outside the university. While this may appear to shield you from the need to take a license, be careful – you may be breaking your employment contract. If this is your plan, talk openly with your PI and the tech transfer office, and if there is no real conflict they may be happy to give you a letter that disclaims any interest by the university in your weekend projects.
Start Fundraising. Negotiating the full license with a license officer can take months, but don’t let that stop you from beginning to fundraise. With a team from a top university, all founders on board, and a licensing option in hand, many companies have been able to raise money before completing the full contracts. Firms like Pillar and Petri are typically willing to write an initial check before the license is signed, especially if they are familiar with the license officer and can reliably expect the deal to come through on reasonable terms.
For an in-depth guide on raising seed funding, check out the Pillar VC How to Raise Seed Funding Guide.
Review plan with TLO and reach terms (2-4 months)
Now that you know you will proceed, even though you do not yet have funding, it is time to start the licensing process seriously. Contact the licensing officer, meet and explain your business plan and momentum, and then ask them for terms on a license.
You’ll want to find an IP lawyer who can help you through the licensing process. This probably will not be the same person as your corporate attorney. Past university licensing experience is critical, so they can help you benchmark the terms and better negotiate while avoiding oversights and mistakes.
Two of the most common questions we get from founders beginning to embark on this process is what to expect on terms, and how to create leverage in the process.
Expected Terms. Terms vary widely by university. You can learn a lot by asking other founders who spun out of your university what they experienced. Experienced counsel may also have worked with your university before and be able to accurately predict the terms.
Check out the IP Fortress for a description of common terms in University Licenses.
Creating Leverage. It sometimes feels like a university holds all the cards in the licensing negotiation because they own the patents. Don’t forget that the university also needs you, and needs you to succeed, because otherwise their royalties will not amount to anything. If you are the only person in the world who can take an invention forward, then you do have real leverage.
University licensing officers are generally attracted to the job because they do want to help new inventions become commercialized. While they are professional negotiators, in the end they are rooting for you and will want to help you make the invention a big success.
A tactic you can use to add to your negotiating position is to close a small seed round or conduct a “first close” on a fundraising in progress. That lets you get started without further delay. This can help you stay patient to make a better deal. Additionally, as the company starts to file its own patents, you may be in a better position to negotiate.
While university licensing officers are professional negotiators, they are rooting for you and want to help you make the invention a big success.
Don’t let the tone become adversarial. Your relationship with the licensing officer will be a long one because you will be reporting back, discussing patent prosecution, and making small adjustments to the license periodically for many years.
Once the terms are agreed, perhaps in an informal exhibit, the licensing officer will work on a full license, which you will negotiate with the help of your lawyer.
Complete the full license and seed round (2-3 months)
The full license is a 30- to 50-page document that may take another 2-3 months to finalize and sign. This is a key milestone in the birth of the company because you now control a valuable patent or patent portfolio.
Although some VCs will want to wait for the full license to be signed before investing; others (including Pillar & Petri!) will back companies before full license agreements are in place, as long as the terms are clear and agreed.