University Spin Out Companies

Some of Scotland's most successful companies were started as university spin out ventures. There are several key issues for those contemplating such a venture which need to be fully considered at the outset.

Choosing the right investor

The choice of investor is all-important. Whilst for some it may well be a case of "beggars can't be choosers" it is important to bear in mind that despite all the market turmoil of the last twelve months there are still many investors in Scotland willing to participate.
While company founders might dream that their investors plough plenty of cash in and take a very hands-off approach to the day to day running of the company, it should not be forgotten that many investors can provide invaluable support and experience in management issues. However, others have taken this principle too far, and have been heavy-handed in their attempts to direct the company's development. The bigger investors have to report to boards and other third parties, and although they perhaps have more sums at their disposal they can also be more demanding in their involvement than, say, angels. Most if not all of the frictions that arise tend to emanate from a lack of appreciation on both sides of each individual's role and skills, and how these roles and skills are best utilised for the gain of the company.

Ultimately, the founders will have to decide at an early stage whether they feel that the investors share their view of the best interests of the company. It is worth checking out at the earliest possible stage the track record of investors, both as individuals and as organisations. Speak to others who have used the same investors to find out what their experience has been.

The ongoing role of the university

Depending on the nature of the product or service, universities will normally expect to receive some form of ongoing share of revenue on the grounds that they originally owned and initially developed the IPR. In typical cases royalties will be 2-5% of sales, but this can vary widely according to the specific circumstances. In addition, universities will usually want a shareholding in the company. Until recently a 5% shareholding was the norm, but over the past year some universities have looked for as much as 20%, which can create significant problems in putting a deal together. With the shareholding may come a right to appoint a director and/or attend meetings. Currently the universities tend not to be particularly aggressive in this area, as founder directors are often sufficiently well connected with the university to be deemed to act in the university's interest. However, the commercialisation units at the universities are increasingly confident, and can be tempted to negotiate the terms of spin outs in a more challenging manner.

Future funding

Companies which grow rapidly will need to go through several rounds of fundraising, and for this reason it is imperative that the initial funding is done with subsequent rounds borne in mind. In the excitement to get the company up and running, the founders often overlook the fact that future investors will examine for themselves the appeal of the original investors (the individuals, and the terms and conditions of their investment). An illustration of this point was the demand by an otherwise suitable investor to take 20% of the revenue share until annual sales reached £5m and 10% thereafter. If conceded, this sort of request can cause significant problems with new investors in subsequent rounds, and might be sufficient reason to refuse such an offer.
It is equally important to look to the effect on future investors when planning product development. The current speed of technological change may very well mean that by the time that the business is looking for second or third round funding, the market, core or associated technologies will have advanced. Founders should bear these threats in mind when positioning the product or service, because the accurate prediction of the market in the future will have a direct effect on the exit strategy adopted by the investor.

For more information on Young Company Finance, refer to its website at www.ycf.co.uk

[top]