Spin Outs and Start Ups - New Companies to Commercialise Intellectual Property from University Research

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Cathy Garner and Philip Ternouth.¹

New company formation has grown as an important route to commercialise technologies from research institutions. Although new company formation may not be the most efficient route to market for all technologies, to those concerned with economic development, the formation of new, successful, high tech companies is seen as a route to create highly paid and support jobs. Many countries have sought specifically to support this trend by the formation of "business incubators" and science parks to create a supportive environment. This paper sets out those factors which can contribute to successful new technology company formation from the science base. It does not specifically address the decision process which is necessary to determine whether indeed new company formation is the best route to market

Introduction

The trend for the generation of new companies from the science base began in the USA as a result of the contribution the university sector made in the interests of national defense during World War II. That experience emphasised the need for a strong commitment to partnerships and linkages among industry, academia and government research sectors. The value of university research as a vehicle for enhancing the economy by increasing the pool of knowledge which could be used by industry through support by the government was first recognised in the USA by Vannevar Bush, the Science Policy Adviser to President Roosevelt in the 1940's.² The story of Silicon Valley and its start-up successes is legendary.³

In the USA at present there is substantial start-up activity. In the financial year 2002 some 450 new companies were formed to exploit the technology based on academic discoveries reported by 214 universities with start-ups responding to the Association of University Technology Managers survey⁴. Some 4,320 start-up companies have been created since 1980 and of those 2,741 are still in operation. Notably eighty- three per cent of the companies created in 2002 were based in the university's home state. One-hundred and thirty one institutions reported at least one start-up while two institutions reported 23 each. Of the 4,509 licenses, some 68% were to new or existing small companies, those with fewer than 500 staff. 91% of licenses to new companies were exclusive compared to 45% to existing small companies and 38% to existing large companies. Similarly in the UK a recent report on UK Universities⁵ shows that licensing income has fallen in recent years, possibly because public authorities are pressing for the creation of more start ups.

Conditions which contribute to successful New Technology Companies

There are a number of perspectives which may be taken into account when examining whether the formation of a new company is the best way in which to commercialise a piece of technology. However, there can be little doubt that from the perspective of the successful introduction of a new product to the market, the new company route is higher risk than a traditional out-license to an existing company. In general, the circumstances which favour the establishment of a new company to develop products and take them to market are those in which the same "offer to market" cannot be made by licensing the technology to an existing company. Conversely, where such a licensing arrangement is available, a new company is unlikely to generate the same value for the owners of the technology or succeed in making the product available as effectively as the licensing arrangement.

An existing company which has the necessary infrastructure already in place - such as channels to market, facilities and commercial management, sector knowledge, and an existing contacts network, is likely in most circumstances to represent a lower risk. However, where the new technology is of a disruptive nature and/or where it is far from the market as is the case for university research-based technologies, then the "new company" route may be the only realistic alternative. In addition, the political priority for new jobs and local economic development brings additional pressures and benefits from the "new company" route.

New company creation from research institutions can benefit from a phase of existence as a "virtual" company. This phase can last for a long time under the spin-out route from universities and indeed there have often been companies which have existed solely within universities without clearly defined boundaries. The "virtual" phase can be useful in preparing the company for a stand alone existence and indeed in times of volatile venture funding for specific technology sectors, may allow new technologies to be brought closer to market without the burdens of a formal legal existence. In the UK under certain economic development seed funding (the Scottish Enterprise Proof of Concept Fund⁶ is a good example); the virtual model is a condition of funding. However, in due course, companies must take on a separate existence and are typically legal entities ("corporations") in their own right established to conduct a business.

The following factors are the ones which experience has shown to be critical to success or failure

• Technology. A technology which provides a substantial but incremental improvement over an existing product category (as opposed to a platform technology) is most likely to be effectively licensed to an existing company. Existing products have existing markets with existing established channels and customers with which it is risky to set up in competition. Platform technologies, on the other hand, are those which enable a range of different products to be produced, possibly for different markets. Frequently, the way to get the best value from these and ensure that the technology is fully exploited will be to form a new company. This may or may not address the markets directly, depending on the marginal costs and benefits arising from each. Platform technologies are frequently attractive to investors as the range of potential markets which can be developed offers a greater security of return if the initial intended application fails. There is likewise an implicit chance of greater returns than a single product technology.
• Market Development. An existing market (defined as the sales of products of a particular type to a defined group of customers) is most likely to be served by a range of competitors with existing customer loyalties and established distribution channels. In such a situation a conventional license is most likely to be the best route to market. Conversely, where a market is new, the licensing route may not be available or will be higher marginal cost for a prospect licensee. In this situation there will also be a higher expectation for return on investment which ultimately makes the license attractive. All these factors mean that forming a new company may be a better option financially provided that that the potential market demand exists.
• Product, System, or Component? If the intended product is a complete system then it will be theoretically possible to form a start-up or spin-out to take it to market, as the company may be capable of providing a solution to end users. If the intended product is a component of a larger system, then it will need to be channeled via established companies in the field who will embed it in a complete system, unless for other reasons the technology can be licensed to existing companies to add new products into existing systems or replace existing technology (in which case a license or development to license may be a viable option).
• Availability of Management. Development of a technology is heavily reliant on finding capable management. Marketing the technology well (presenting it in the context of its compelling benefits in product form) will enable the technology assets to be used to leverage these management resources from the marketplace. Conversely, if it proves difficult to attract management to a proposition, this may be because the other requirements for forming a new company are not met. Choosing to go through a licensing route effectively co-opts the management of existing companies into a new product's channel to market.
• Market Concentration. A concentrated market has the majority of its value in a limited number of customers. A diffuse market has the value dispersed in a large number. It is easier to locate and access a limited number of large customers than it is to locate and sell to a large number of small ones. Exploiting an existing distribution channel via a distributorship arrangement may be the only economical way of addressing the latter even if there is genuine new product or company potential.
• Complexity of Sales Task. If the sales task is complex, which it may well be with a new product concept, where the type of product is unknown to the customer and the benefits unproven, it may only be the originators who have the capability to describe its features adequately and work with innovative customers to prove its utility. In such circumstances, the best option would be to work through a capable marketer and adequate training mechanisms to enable the marketer in presenting the product correctly.
• Availability of Investment. For a development which goes all the way from technology to market, investment may not be available for the complete project, because of the high costs and risks involved. A licensing route or development to licence may be the only one for which investment can be made available. If it is feasible, then it may be that the other factors which favour licensing are also present. The classic example of this is the drug development and marketing process, where the costs of Clinical Trials and Regulatory Processes may be over $100 million and the attrition rate higher than 90 per cent.
• Complexity of Delivery. If the delivery of the product or service is highly complex, it may require the services of a coordinated team and detailed knowledge of the technology underpinning the product. New companies intending to exploit the sciences of biotechnology are entering an environment that requires collaboration. There are many different processes needed in a complex value chain to market in which the direct chain runs through target identification, compound design or synthesis and screening, and then drug development and market. This requires a supporting infrastructure which might include the production of animal models of disease, bioinformatics, gene sequencing, chemical synthesis, combinatorial chemistry, drug delivery, formulation and manufacturing, clinical trials management, biostatistics and the management of regulatory approvals.

• The interdependencies of different skills and specialisations means that producing a start-up company which can develop and market its own products is very unlikely to succeed. Moreover, the pace of scientific advance worldwide will mean that simply keeping up to date with relevant discoveries is hard. Interpreting what their implications might be for existing projects or new opportunities are even harder. The sequencing of the human genome has generated more potential disease targets than even the largest pharmaceutical company can handle. These circumstances together place a large premium on collaboration. Collaboration is a strategy for large companies to increase their project pipeline and for small companies to obtain the resources they need to develop their products. The ability to collaborate and access resources in other companies is a competitive capability in its own right, and it follows that new biotech companies should plan their strategy around developing this ability and identifying potential partners early in their development. This necessitates both an openness and readiness to work with other companies to identify projects on which they might collaborate, but at the same time develop a high degree of professionalism in managing the formal aspects which protect their commercial interests. This will include the protection of commercially sensitive information and materials under Non-Disclosure and Materials Transfer Agreements, and above all the protection of their intellectual property by filing and prosecuting patent applications.

Conclusion

While there have been many significant success stories on specific start-ups from the science base and the impact that the growth that such companies have had on local economies, such as in Silicon Valley, California and Route 128 on the East Coast of the USA, the discussion here has pointed to the complexity of the task. The choice of "route to market" for new technologies is a set of complex decisions which many universities and research institutions are not specifically equipped to undertake. New companies once created, have many challenges to achieving sustained growth and successful delivery of value to shareholders. Technology alone is rarely sufficient to achieve this goal. More important is good management, awareness of market forces and a good supporting environment in the early stages. For those which do succeed, the returns to the founders, the institutions and the local economy may nonetheless be important. For certain technologies, the only route to market may be through new company formation, however, further study is needed on whether the optimal balance in economic development is being achieved by the current prioritisation of new company creation over licensing to existing companies.

Article extracted from the Handbook of Best Practices for the Management of Intellectual Property in Health Research and Development, available on the MIHR website. 

¹ Cathy Garner is the Chief Executive Officer and Board Trustee of MIHR. Philip Ternouth is the Chief Executive Officer of IPR Ltd. And a Visiting lecturer of the University of Manchester Institute of Science and Technology (UMIST). The views expressed in the article are those of the author and do not necessarily represent those of WIPO.  For a full discussion, see Richard Mahoney (ed) Handbook of Best Practices for the Management of Intellectual Property in Health Research and Development, MIHR, Oxford, 2004. (www.mihr.org).  MIHR is a not-for -profit, UK registered charity, which specialises in advising on the management of IP for social and economic benefit in health for the poorest.

² Howard Bremner, "Technology Transfer: the American Way", International Patent Licensing Seminar, Tokyo, Japan, January 2003.

³ The New New Thing, Michael Lewis, 2000; Economist Supplement, March 1997.

⁴ AUTM Licensing Survey FY2002 - see http://www.autm.net

⁵ UNICO/NUBS Survey of UK Universities 2002.

⁶ Scottish Enterprise - Proof of Concept Funding Programme - www.Scottish-Enterprise.com.