Startup Spotlight: ‘Tech transfer’ from Triangle universities could be much better – here’s how

Editor’s note: David Gardner is founder of Cofounders Capital in Cary and is a regular contributor to WRAL TechWire. Startup Spotlight is a regular part of our weekly new venture coverage.

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CARY – Everyone seems to agree that universities can be a treasure trove of new technologies and that startup ventures commercializing that IP can be a valuable revenue opportunity for the inventors, entrepreneurs, investors and universities. Such being the case, and with more than our fair share of major universities in the Triangle, why aren’t we seeing a lot more successful exits from startup companies based on technologies spun out of our local universities?

David Gardner (Cofounders Capital photo)

You only have to mention the words “tech transfer” to get most professional investors to roll their eyes. They can all tell you stories of how frustrating these deals are to negotiate and why, in general, they tend to avoid deals with university licensing strings attached. This is really unfortunate for all of the stakeholders involved because early-stage venture capitalists are experts at ongoing funding and guiding the strategies and management teams to successfully build companies based on new technology.

If there is so much to gain from universities and investors collaborating, why don’t they have a better track record of working together on startup ventures?

Let’s look at some issues

I believe that most of the problem lies in how universities think about tech transfer. Universities tend to view all tech transfer in terms of a royalty arrangement. That structure tends to work fine when licensing a patent to a large corporation but it is usually a poison pill for a new venture raising capital to commercialize a technology.

A startup is funded by a group of like-minded investors who agree to take a certain percentage of equity in exchange for the capital they put at risk in that new venture. The investors’ goals are all aligned. They know that if they expand the stock option pool to attract better talent or raise more working capital then they will all be diluted proportionately by those business decisions. As is often the case, when the venture is behind plan and needs more money to survive, the investors know that they will be on the hook to put that capital in to protect their initial investment. They are all in the same boat sharing the same incentives and risks.

Universities don’t want to be in that boat. Rather than viewing themselves as a co-investor alongside other investors, they try to force fit every tech transfer deal into a royalty arrangement which is paid to the university regardless of how well or poorly the venture is doing. If more capital is raised, etc. the university does not need to participate or even be diluted by those business decisions. The other investors must bear those costs alone. If certain minimum royalty payments are not made, then the technology transfers back to the university and they are free to try again with a different group. The cash investors lose all of their capital while the university loses nothing.

The royalty deal structure does not sit well with venture capitalists or other cash-investors in a venture. They reason, why should their capital be at risk when the university is risking nothing? Why should the university not suffer dilution when new capital is raised like the other stakeholders? Why should the university be the only investor taking profits from a venture that is probably not profitable yet and continually having to be propped up by more capital from the other investors?

Risks & obligations

Investors feel that if universities want to play in startup world, then they should be a good partner and take the same risks and obligations they endure. That means, taking equity in exchange for their tech contribution in the same way other investors are taking equity in exchange for their cash contribution to the venture. This would align everyone’s goals and risk/reward profile.

There are lots of other reasons to avoid royalty entanglements in a startup. It makes it very difficult to raise later rounds of funding from new investors for many of the same reasons discussed here. Also, new investors don’t want to give up their liquidity preference. In a meltdown, selling the technology can often help investors get at least some of their capital back but not if that technology is owned exclusively by the university.

Although the royalty model may work well when licensing IP to large corporations, it is simply the wrong model for a startup venture. It makes it difficult to raise money from sophisticated investors who can significantly increase a venture’s access to future capital and the probability of success. If our universities stop viewing every commercialization project as a royalty stream, they could help to create many more successful startups and entrepreneurs in the Triangle.