Key areas to consider before setting up a spin-out company
1. Deciding on a spin-outThis can be an attractive route for many entrepreneurial academics, providing an opportunity to commercialise technology within their area of expertise. However, setting up a spin-out is a demanding process. It will divert you from existing research and academic work, and you will also be working closely with business managers and corporate investors who may have a different agenda and approach from you.
2. FundingMost spin-outs get funded initially by a combination of grants and equity investment. You need to have a compelling proposition which identifies market need to convince investors to fund spin out companies, as they are perceived as relatively high risk. Most spin-outs approach business angels or the venture capital community, but there may be a ‘seed fund’ dedicated to your university or an informal network of investors with which the university has arrangements – so ask around. Whatever the source of funds, the key is securing sufficient funding to allow you to break-even, or at least achieve a meaningful milestone which will justify new investment at a higher company valuation.
3. Construct a strong teamAny potential investor will want to see that the company has a strong commercial focus and business model. Often academics can find themselves outside their comfort zone when it comes to running the commercial side of the business. Ensure that you have a strong leader with commercial business savvy, as well as knowledge of the technology/IP aspects. Demonstrating understanding of the market and how to sell into a customer-base will be key. The challenge here is that a spin-out company will struggle to achieve funding without a strong management team, and yet attracting the best individuals without having funding in place can be hard to do.
4. TaxationThere are various important tax reliefs which may be available to external investors and academics subscribing for shares in a spin-out, provided that certain criteria are met. Tax relief is generally available for academics who have been involved with the technology to be used by the spin-out. This neutralises the income tax and NIC charges associated with the value of the IP transferred from the university to the spin-out. Strict conditions and chronology have to be met, including as to the timing of the issue of shares and the IP transfer agreement. In addition, subject to a few conditions being met, entrepreneur’s relief may be available to reduce the capital gains tax on the future sale of shares. Enterprise investment scheme relief (known as EIS and seed EIS) may be available for external investors, which will give them tax breaks on amounts they invest.
5. Legal advice/IPThere will be a number of legal steps and documents required in relation to the spin-out. Documents such as a shareholders’ agreement or investment agreement, articles of association and directors’ service contracts will all need to be prepared. It is also crucial that the IP is secured and that everyone is clear as to who owns what. Often there will be a licence agreement in place in which the university will make IP available to the company on an exclusive basis. This will include key milestones in order for the company commercially to promote the IP effectively, a right for the university to revoke the licence (and usually a corresponding right for the company to acquire the IP outright if milestones are achieved), and other financial provisions including royalties or equity-in-lieu. The terms of these agreements will have a significant bearing on the success of the spin-out, and it is well worth getting good commercial legal advice. Mistakes at the outset can be very costly in the long run. Will McIntosh is a partner in Brodies LLP’s corporate and commercial team.
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