Tech Transfer Office Shouldn’t Be Your First Stop –

We have written in this column about early stage corporate IP (intellectual property) spinouts-extracting technologies and teams from inside high-tech corporations and creating new early stage venture-backed companies.

We view corporate IP spinouts as an effective method of achieving capital efficiency by leveraging corporate R&D dollars and reducing a startup’s venture capital requirements, in the process allowing for venture-style returns in what we expect to continue to be a valuation-constrained exit market for the next five years.

Our discussion in last month’s VCJ generated a healthy debate between the merits of corporate vs. traditional university research After all, Cisco, Google, Sun and Yahoo all trace their lineage back to Stanford University. No doubt, universities generate vast amounts of research, some of which has commercial potential. Since passage of the Bayh-Dole Act in 1980, universities have greatly increased their efforts to commercialize their research. The Bayh-Dole Act in fact creates an obligation for universities to seek to commercialize government-funded research.

So how do universities compare to corporations as fishing ponds for early stage venture investors? While some universities have a rich legacy as the source of leading technology companies, with Stanford as the prime example, investors have to consider the challenges, risks and benefits of university spinouts against those of early stage corporate IP spinouts. Word of caution: this analysis pertains only to IT spinouts. Life science research and spinouts live by a completely different set of rules.

When considering an early stage IT spinout, investors need to focus on four key elements: people, technology, deal structure and the engagement process.

People

The team is arguably the most important element in any new venture. When comparing university to corporate “types,” investors should consider that academics-to make a gross generalization-are less interested in doing the nitty-gritty hard work required to be a technology entrepreneur. They tend to be on a tenure track and motivated to publish in academic journals and build credibility among their academic peers. It is often difficult to get tenured professors to join a startup full-time (although most are willing to consult or work part-time for the new venture while they maintain their academic credentials). But how many VCs want their core technical team to be part-time and only partially committed to the venture’s success? The reality is that most academic researchers are not “socialized” in a culture that is supportive of commercialization and entrepreneurialism.

Or course, the same might be said about the people in a corporate IP spinout. Corporate “lifers” may not have the entrepreneurial DNA to step across the chasm from defined pension benefits to the unknown of venture-land. A corporate “type,” to again generalize, may not have what it takes in the risky world of startups. Does this make them better or worse than academic founders?

Given a choice, we think corporate technologists are more closely suited to a life in a startup. For starters, they have self-selected to go to work in a profit-making corporation. More importantly, they view their success being tied to broad acceptance of their technology-whereas academics see their objective to be publishing and peer recognition. Corporate entrepreneurs are also accustomed to “selling” their products, albeit internally, with an eye toward the NPV of a given project. Corporations, like VCs, ultimately care about making money, something that cannot be said for universities.

Finally, despite the success of Stanford and several other universities in spinning out technology, universities may actually be heading away from commercialization efforts. Some prominent academics have recently cautioned about changing the core mission of education and public research, most prominently former Harvard President Derek Bok in his 2003 book Universities in the Marketplace: The Commercialization of Higher Education. Sheldon Krimsky of Tufts wrote in his book Science in the Public Interest: “Because of a few significant gains by a few universities, others feel inclined to jump on the tech-transfer bandwagon. However, there are very few universities that can get a windfall profit from a patent or equity investment in a company.” Advantage: corporations.

Technology

You may be thinking: “I thought the real cutting edge research was done at universities.” This is mostly true, but much of it is very early and highly speculative, making it difficult to build early stage IT companies around the technology. No doubt, research in areas such as quantum computing and molecular computing is very cool, and may eventually have significant market impact, but not for a decade or more-well beyond the time line for exiting venture investments. This leads to the “Valley of Death” problem: it could be a death march of tens of millions of dollars more in research and marketing to get the raw academic technology across the desert to ultimately prove (or worse yet, disprove) its commercial prospects. Also, corporations have spent more on research than the government in recent years. Whereas the government out-spent industry in research funding by a 2-to-1 ratio in the 1950s, industry today out-spends government by a 2-to-1 ratio. Finally, while many university tech transfer offices fervently shop their patents to generate licensing revenue, the reality is that IP transfers through people, not paper. Good VCs can build a successful company with a core nucleus of 4-6 key technologists-the “sweet spot” for corporate IP spinouts-but very few VCs are interested in building a company with a patent license alone. Advantage: corporations.

Deal Structure

Structuring any spinout deal is complicated. Not only must VCs deal with the team and the co-investors, but they must also deal with the parent-either the university or corporation. Our experience has been that corporate IP spinouts, while certainly challenging, are more likely to get structured in a way that increases the likelihood of success than university spinouts. Most university tech transfer offices are required to be self-funding. As a result, most IP licensed from universities is offered on a cash royalty basis rather than on an equity basis. Even Stanford, which is the parent of an estimated 1,200 companies, holds equity in just 80 companies. From a VC’s perspective this creates a “tax” on a company’s cash reserves. Corporations, on the other hand, are generally less motivated by small royalty streams that don’t “move the needle” of the corporate P&L and are therefore more open to taking small equity positions in lieu of royalties.

Unfettered access to IP can also be a problem with university spinouts. While universities are open to exclusive patent licenses, they are typically unwilling to assign patents outright. In addition, nearly all of the university licenses are revocable. What VC wants to have his investment evaporate when a university tech transfer office decides to pull back a license?

There are other structural issues with university spinouts, as there are with corporate ones. Both take time, patience and tremendous effort. Difficulties with departmental politics, time pressures, deteriorating relationships with universities, slow moving institutions and unhelpful technology transfer offices are common in university spinouts. Organizational challenges also occur in negotiating with corporations. That said, our sense is that because of the cultural gulf between market-oriented VCs and research-oriented academics, the problem tends to be worse in university spinouts. Advantage: corporations.

Engagement Process

Universities do have one clear advantage over corporations: you can find the front door. Nearly all research universities now have tech transfer offices with web sites and clear contact information. Corporations, on the other hand, rarely advertise their technology suitable for spinout, and it can be difficult to figure out who actually controls the corporate IP and governs the IP extraction process. While universities have an advantage here over corporations, this means that the VCs have to work harder to identify the right people in the corporation that can generate spinouts. Ironically, this barrier to entry can be advantageous to some VCs. Those VCs who have established the right corporate relationships have a major deal sourcing advantage over those VCs still struggling to find the front door. Advantage: unclear.

We believe that for IT-focused investors with a strong requirement of capital efficiency, corporate IP spinouts offer a key ingredient to success in early stage ventures: a high degree of prior investment and venture capital leverage. University research also offers some advantages for firms specializing in commercialization efforts and several prominent successes exist. Both models are likely to persist in the years ahead and investors are likely to draw their own conclusions from both models.

Bart Schachter is a Managing Partner with Blueprint Ventures. He focuses on comm. and IT infrastructure, wireless technologies, nanoelectronics, software and comm. semiconductors. He may be reached at bart@blueprintventures.com. Jim Huston is a Venture Partner with Blueprint Ventures. He is a 20-year veteran at Intel Corp. and was most recently Director of IP Acquisitions at Intel Capital. He can be reached at jim@blueprintventures.com.