IP Licensing for a Spinout Startup

One way to begin a new entrepreneurial adventure is to find some attractive intellectual property and license it as the foundation of a new startup. Here are some of my lessons learned for such a path.

As a serial entrepreneur, my success rate building high-potential startups has been greater when I began by licensing some intellectual property from a team of brilliant inventors who have done some heavy lifting generating and validating some innovation rather than just starting from just a good idea. Of course, that puts a premium on my ability to screen the abundance of inventions available for license for the ONE that I am going to pour years of my energy and passion into as I seek to realize the potential of the opportunity.

Advantages of the Licensing Path

There are research and development organizations that have a mission to generate exciting innovations. Examples include research universities and corporate R&D departments. These organizations are designed and resourced to do the earliest stages of ideation, creation, and poof of concept work, with the expectation that, in many cases, successful concepts will be licensed to other parties for full development and commercialization. Entrepreneurs can play a vital part by identifying promising technologies, validating unmet market needs, raising money, and building a team to execute on advancing an innovation through some of the development and commercialization stages.

For an entrepreneur, one of the advantages of the licensing route is that some of the early development and proof of concept work is completed, shortening the pathway from initiating the startup to having a viable product to launch commercially. I have done startups both ways – beginning with just an idea and having to fund all the earliest stages and, on multiple occasions, licensing some intellectual property (IP) that is further along. Given my predominantly business and company-building background, I have developed a preference for finding great technical teams that have created some IP that has shown some evidence that it works.  I then rally the resources and strategy around quickly advancing that idea through some critical value inflection points. It is far easier to raise money for something with some data and evidence that the technology works because the risk is lower and the time to market is much shorter. In addition, there are often technical people involved in the early development who are excited to join the startup and see their concept successfully brought to market but who don’t have the requisite set of skills and contacts to credibly form, fundraise for, and build a startup company on their own. 

Where to Find Possible Licenseable Innovations / Possible Licensors

Research universities are a gold mine of amazing ideas. Corporate R&D groups often discover things that will not be big enough business opportunities for them to develop fully, however, they are happy to license out the “smaller” opportunities, which can be quite a nice size for a startup. To explore the possible technologies available, seek out the Offices of Technology Transfer on university websites and inquire. Sometimes, for corporate R&D groups, the best way to find them is to network within the entrepreneurial ecosystem to find possible corporate R&D contacts. I suggest checking with corporate or licensing lawyers, accelerator staff, and serial entrepreneurs who have been around the community for a while to identify who may be aware of possible contacts. Do not be shy! Technology transfer professionals at licensors are motivated to find good licensees to partner with.

Buyer Beware, a.k.a. Opportunity Evaluation

As a licensee or “buyer” of the technology, you must carefully vet the opportunity. To illustrate, once, when I was reviewing a list of licensing options, I commented to the licensing professional that “we” both wanted me to identify a good business opportunity on their list. He set me straight when he quipped, “I don’t actually care if the opportunity is good or not. My goal is all about getting license agreements, and it is on you to figure out if it is a good opportunity.” Buyer beware! 

So that brings us to the question of determining what is a good opportunity. Many posts on this blog relate to identifying a good opportunity. Still, in summary, for a licensing opportunity, you will want to do some direct customer discovery with whoever you would ultimately sell the product to, evaluate the evidence that the innovation works, assess the market size, estimate both potential selling price and cost to see if you have a potentially profitable business model, understand any regulatory hurdles, and check out the competitive landscape. Along the way, make sure you are thinking about who you might recruit onto your team to champion the further development of the technology you plan to license. There may be graduate students or a receiving technical team that can carry the ball forward. You want to ensure you thoroughly and carefully evaluate the people you might have join your team.

Basically, remember that if someone has been securing grants to fund the development of their innovation, this is a double-edged sword. The good side is that grant applications are a goldmine of information making a case for the innovation, and if they have been successfully funded through a peer-reviewed process, that is a layer of confirmation of the potential. The bad side is that it is easy to believe that funded grants are sufficient due diligence. They aren’t. Remember that successful academic inventors develop tremendous skills in securing grant funding. I have more than once uncovered grant-funded ideas that did not survive the rigor of an independent opportunity evaluation. Make sure you get out there and go beyond what the academic team can give you. 

What is there to License?

One of the essential purposes of the patenting system is to provide a mechanism for disclosing and transferring ownership of novel innovations. The patent system offers a limited period of exclusivity to allow the owner of an invention to exploit that invention. If you are doing a spinout, you are building your startup on the foundation of intellectual property that was developed by someone else (the licensor who owns the IP) who then transferred the rights to exploit that invention to your startup (the licensee who wants to use the IP) through a particular type of contact called a license.

When you are looking at a licensing opportunity, you need to evaluate what the intellectual property consists of. Are there patent applications or issued patents? Who can check out the intellectual property position of the licensor for you? Is there specific know-how that you need along with the actual patents? Are there other tools, papers, prototypes, or other information that would help you develop the invention? Can you secure a commitment for ongoing consulting from the group that developed the innovation? Investigate the IP carefully to see what you get and what is missing. Rarely will the license be a fully-formed, revenue-producing product, so you need to formulate a development plan and determine what resources you need to execute it.

License Negotiation Tips

Negotiating a license agreement is a complex process that requires careful consideration of various factors to ensure you end up with a balanced, fair, and legally sound contract. Importantly, I am not a lawyer, and you should employ the services of a competent licensing lawyer when working through the details of a license agreement, as there are plenty of terms of art and ways to miss essential things in licensing agreements. My lawyers have saved me more than once, and I commend their services to you. With that disclaimer, here are a few thoughts to consider as you negotiate an IP license:

• As with most negotiations, begin by trying to understand the priorities and needs of the other party. What is vital to the licensor? Seek to understand their priorities and then use that information to try to emphasize giving them more of what is most important to them in trade for things that are important to you, whenever possible. This is the route to the wonders of the win-win scenario, where both sides come out ahead.
  
  
• Determine the scope of the license that you need. What specific IP assets are you seeking to license? Do you need an exclusive license, or will a nonexclusive license do? What is the duration of the license? Are there any limitations on the field of use, territory, and scope of patent rights? The broader and more comprehensive the license, generally, the higher the price.

• Understand what the major dimensions of the license consideration will be. Examples may include royalty rates, license fees, progress payments, equity stakes, responsibility for prior and future patent expenses, special rights such as data use agreements, rights to manufacture, first rights of refusal, and other special rights that benefit one party or the other. Think carefully about what your startup needs to succeed. Perhaps there are ways to use the license to provide a framework for continued collaboration between the parties.
  
  
• Be creative with balancing near-term cash expenses (when a startup’s resources may be minimal) and longer-term payments. Sometimes the licensor, as a large organization, may be able to essentially float the cash for the startup by deferring expenses to a later point. For example, perhaps reimbursement of patent prosecution expenses might be at exit rather than upfront.
  
  
• Understand that, given the limited life of patent rights, the licensor has a legitimate interest in seeing the licensee develop and commercialize those patent rights expeditiously. This often takes the form of milestone payments and rights to reclaim the patent rights if the licensee is not diligently pursuing commercialization. This is a reasonable expectation, so focus on negotiating practical steps towards commercialization as milestones that align with the startup’s plans. Be conservative and plan for some delays to occur since, more often than not, delays will happen.
  
  
• If an exit is possible in the startup’s future, consider how the license terms will help or hinder that process. Think about how a future transition of startup corporate ownership will be supported under the license terms since that is one of the ways both startups and licensors can realize a return on their investment. Keep in mind that royalty rates must be considered commercially reasonable for the industry involved, or they may prove to be a significant and possibly fatal hurdle to getting a strategic deal done.
  
  
• Remember that the licensor and licensee came together because there is synergy between the invention capability of the one with the development and commercialization capability of the other. It should be the case that both will benefit from the successful exploitation of the invention, provided the license terms are reasonable enough that they do not impede the startup’s ability to raise money and successfully execute its commercialization plan.

Once you have identified the key terms, negotiate them with the other party. This may involve going back and forth to reach a mutually agreeable set of terms. Once the terms are agreed upon, the agreement needs to be drafted. This should be done by a lawyer who specializes in IP law to ensure that the contract is legally enforceable and that all necessary provisions are included. Ultimately, carefully review and sign the agreement. Then celebrate before you begin the hard work of turning the license into value.