Thursday, April 6, 2006
Are you an inventor or entrepreneur seeking to license technology from a university, hospital or other institution?Perhaps it’s a product, mechanical or medical device, a diagnostic or other technology. Perhaps it’s something you’ve been working on and developing at the institution, or perhaps its technology that you as an entrepreneur or investor have become aware of and believe you can commercialize.
As you consider forming your startup company, questions arise:
- At what stage of development can we attract seed investment?
- How do we assess marketability?
- What terms does the entrepreneur or the VC seek in licensing?
- What royalty? What license fees? What equity for licensor?
Assess the market, need and quality of intellectual property. The CEO and entrepreneur should work closely with the researcher and inventor. Typically, the impetus for a successful venture comes from the inventor, but the entrepreneur must understand the marketplace. The inventor alone or often working with a business entrepreneur must assess the unmet need, to translate research into much-needed products or services that will sell.
They must also assess the robustness of the intellectual property — the novelty of the invention — whether a real paradigm shift has occurred, whether the enabling or blocking technology is sufficient to support a new company.
Timing is important. The technology must be proven enough to attract initial investment. The researcher and businessman entrepreneur or investor must achieve that “buy-in”, that belief that they can succeed, and then approach the institution for licensing, with the position that they are the right team to commercialize the technology.
Preserve cash, use equity in licensing. When licensing technology, preserving cash is central to the startup’s survival. Often the startup will take an option on the technology for six or 12 months to delay licensing and payments. With both the option and license, the entrepreneur wants to limit up front payments and conserve cash. Typically, the parties will negotiate achievable milestone payments over a three- to four-year period.
Often to achieve a reduction in those milestone fees, the startup will offer some of its equity. That equity should be 5 percent or less and often is non-dilutable through Series A. If this can be achieved, both parties will have “skin in the game.”
The licensor will want patent costs, both past and future, paid for by the startup company, and the license will typically provide for running royalties tied to net sales. The licensor will also seek minimum royalties so that it can pull back the license or at least make it non-exclusive if it does not see the licensee making desired progress.
There are considerations relating to sublicensing. Companies often seek to keep sublicensing income, but the contract typically provides for sharing with the licensor. Another important issue in sublicensing is blocking technology. If there is a need for other technology, the company may have to pay out royalties to a third party. Thus, it is important to insist on “royalty stacking” provisions that reduce the royalty the company must pay the licensor when other royalties for new licenses also must be paid. Stacking provisions must be reasonable to enable the company to succeed.
Definitions are important, especially field of use — the licensee wanting a broad field of use to justify the investment and effort to succeed in the startup company. The licensor could later seek to narrow the field if it is not fully exploited. The license must also be exclusive. There can be no competition from the licensor, or funding will be impossible. The licensee also seeks grant backs so that future developments by licensor are included in the license, and control over patent prosecution to assure that IP protection is in line with the company’s business strategy and business plan.
The startup company should also expect due diligence obligations as part of the license. These can include timetables to secure financing, for product development and for first product sales. The license will typically require at least annual reporting to the licensor.
The license is valuable, but the team is crucial to success. The negotiation of a reasonable license with an institution is an important milestone for a startup company. It establishes credibility that can launch the startup company. It creates an IP asset that investors will review in considering funding for the venture. Yet, the license is just a first stage to startup success. Research is not a product. Universities and other institutions license to startups because there is considerable risk in new technology. It will take great effort, skill and persistence to successfully commercialize the new technology now licensed.
While having IP, exclusive rights and a good license agreement are essential, it is the company’s management team that must now attract investment and make the product succeed. Venture capitalists invest in management not just technology.