What is a spin-out?
A spin-out company is an independent legal entity, usually created by the university and academic founders, to lead the development and commercialisation of an innovation opportunity arising from research.
The company is separate from the university, has shareholders, its own employees, usually investors and is managed by a Board of Directors. There are many examples worldwide of spin-out companies formed to commercialise university innovation and some of these are household names. They have not only delivered products and services to meet an unmet need, but they have also created thousands of jobs directly and via their supply-chains.
Even if your idea is not patentable, it does not mean it is not valuable and a great business idea. Some of the most successful spin-outs from universities have been based on non-tangible intellectual property such as specialist knowledge (know-how), software, interpretation of data or datasets, or a combination of all of these.
Why create a spin-out venture?
For researchers, being involved in creating a spin-out venture can be enriching in terms of skills development, new networks established and if the company succeeds, a financial return from the sale of founding equity.
The motivation to create a spin-out can come from various sources, from the personal ambition of the researchers to an approach from an entrepreneur or investor. A spin-out may also be the only way to fund taking a ground-breaking innovation through to product and services that create impact.
For example, this may be the case when existing companies do not want to invest their own resources in risky and early-stage innovations. Large companies often prefer to innovate by acquiring spin-out ventures once the innovation has been de-risked and revenues are being generated.
The criteria that an innovation generally needs to be satisfied to qualify for the spin-out route include:
There needs to be a clear need for the innovation by users/consumers that is not currently met by existing products and services. This compelling proposition needs to be novel and unique, backed up by proprietary and defensible IP. In addition, it needs to be able to maintain its competitive advantage over time, to protect its market share and grow value for investors and stakeholders over time.
The market for the innovation needs to be large and growing, with many potential customers across different regions or segments. In addition, there needs to be a clear understanding of the challenges or pains that customers or users currently face, that the innovation would solve.
Team dynamics and strength is an important criterion that investors look for before they invest in spin-outs. The spin-out team needs to include a mix of both technical and business people. They need to be skilled, motivated, and show that they work well together.
The other criteria that investors look for include whether the spin-out will give a good potential ‘return on investment’, meaning that the investor can see that the spin-out will create significant revenue in future to offset their initial investment. In addition, they need to see a good exit route, or a plan for how what the team will do once the spin-out is successful (e.g., being bought by a larger corporate). Other factors that investors look for include a viable business plan that is cash efficient, and that the team clearly understand what cash they need from investors and what it will be used for.
Finally, to justify the time and effort involved in forming a spin-out, it is important that there is evidence that the new company has the potential to transform existing markets or industries, or create new ones, create new jobs, and have environmental or healthcare benefits.
What’s involved in creating a spin-out venture?
The basic steps involved in creating a spin-out venture are shown below, moving from left to right. The aim of moving through these steps to create a spin-out is to satisfy the spin-out criteria described above.
Working through the steps above usually involves a mix of technical and commercial de-risking. De-risking activities can range from a key proof of concept programme being completed to demonstrate that the innovation will work as a product or service and that it will create real value for users, or perhaps engaging an entrepreneurial champion to take the lead in securing an investment to create the spin-out.
During the spin-out creation journey, it will be essential that, from the beginning, the principal investigator or a member of the research team that created the innovation can dedicate significant time to these de-risking and entrepreneurial activities. The IP & Commercialisation team support you throughout the journey to formation. For example, they will help to negotiate legal agreements for company incorporation, investment and the transfer of intellectual property to the business.
Once the spin-out is incorporated, a wholly-owned subsidiary of the University called GU Holdings Ltd will manage the University’s shareholding in the business and will either have a nominee Director or Observer on the Board. The researcher founders will personally receive shares in the spin-out. They may also participate in Board meetings if appointed as a Director, be seconded to the company to provide expert input, or become full-time employees.
How is a spin-out opportunity funded?
Most university spin-outs require external investment in order to set up and grow the company. The amount of investment required will depend on the spin-out and the opportunity, as well as what’s required for the spin-out to achieve self-sustaining revenue streams.
The main types of investors are angel investors, venture capital funds and corporate venture capital. These different investor types all have different investment criteria, motivation and expectations. The type of investment to secure will depend on each spin-out opportunity and its needs.
In addition, a spin-out could secure non-dilutive grants. Innovate UK offer a range of grants that are eligible to spin-out companies only. Finally, in some scenarios, there are opportunities for spin-outs to self-finance.
For example, if the innovation opportunity is ready to be sold as a product or service and sales orders can be secured, or if the innovation requires development this can be paid upfront by a customer contract and would make the spin-out ready to trade.
Regardless of the funding route, the IP & Commercialisation team can support you and the spin-out team to identify the most suitable funding or combination of funding options for your spin-out.
How do you get rewarded from a spin-out?
The personal rewards from a spin-out will depend on the level of your involvement in developing the business. Some of the ways in which you as a founding researcher of a spin-out may personally benefit in the spin-out are outlined below.
- Equity: Under the current University IP policy, spin-out founders are entitled to no less than 70% of the founding equity in the spin-out, with the remainder owned by the GU Holdings Ltd (the 100%-owned subsidiary company of the University). As described above, usually spin-out companies need investment. Founder shareholders including GU Holdings Ltd ownership will therefore reduce (or ‘dilute’) as external investors invest in the spin-out and join as shareholders. The level of dilution will depend on the pre-investment valuation of the business and the amount of cash being invested. Disposal of shareholdings will require an ‘exit’ event that is normally a trade sale to an existing business or a public listing.
- Consultancy: Once the spin-out is incorporated, founding researchers may, in addition to their founding equity, be contracted by the spin-out company to provide technical input or advice under consultancy agreements. These agreements pay consulting fees, but the University’s consultancy contracts can also reward contribution to spin-out by the award of share options in the company.
- Secondment: On approval from your College, founding researchers can be seconded to the spin-out company for a finite period, for example 40% of their employment time for the first 24 months after the company has been incorporated. Under this agreement, the spin-out company reimburses the University for your time spent in the business. The spin-out company may also directly reward you for these services in addition to you continuing to receive your salary, for example in the form of share options or consultancy fees.
- Directorships: In some ventures, one or more academic founders may be appointed as Directors on the company board. The role of director is a serious undertaking with duties to the company that are enshrined in law and for which each director is personally liable. Director duties include exercising care when making company decisions, acting honestly and responsibly in the best interest of the company, in accordance with the company’s constitution, not to use the company for their own benefit, and avoiding any conflicts of interest.
Financial incentive information can be found here.
Looking for inspiration? Have a look at the spin-out companies that have come out of the University of Glasgow.