The equity shares required by many universities in their standard license agreements with faculty start-ups cause such agreements to ultimately be unfair to one of the parties, according to Scott Shane, PhD, the A. Malachi Mixon III Professor of Entrepreneurial Studies and professor of economics at Case Western University.
Equity shares should be established to appropriately reflect the value of each individual technology and start-up, rather than being expressed in a standard percentage, Shane asserts. For one thing, he says, a common percentage for each technology or start-up assumes they are all of equal value — thus, in most cases the spinoff will either be overpaid or underpaid. “As a result, by offering a standard equity deal to spinoff companies, universities could end up investing in their weakest spinoffs and miss out on owning a share of the strongest ones,” Shane wrote in a recent article for Entrepreneur.
“The basic view is that any time you standardize anything and hit the mean, you will over and undershoot,” says Shane. “As a general principle it is bad policy when you can’t take into account the [variables].” Some of those variables include the quality of the start-up’s leadership, how much financial and other support the TTO will provide, how much outside investment has been secured, the size of the market, the risks related to market acceptance, competition, and regulatory approval among others, and innumerable other factors. With so many differences on these and other critical issues, it simply makes no sense to have a standard equity percentage for every start-up, Shane argues.
The headline for Shane’s article states in part that standard equity stakes are “misguided,” but Robert Woodridge, associate vice provost for technology transfer and enterprise creation at Carnegie Mellon University, begs to differ. He doesn’t disagree with Shane on his criticisms as much as he does on philosophy.
“The funny thing is I found myself reading through the article and agreeing with many of his statements,” says Wooldrige, “but at the end of the article he makes a statement that we are missing out on revenue (CMU’s Center for Technology Transfer and Enterprise Creation uses a 5% equity stake in its standard agreement). My first thought was, ‘Okay, universities are not revenue maximizing; why is that a problem?’ Is that what a university should be doing?”
Wooldridge adds that his “basic unit of discussion” when it comes to tech transfer is dissemination — how many technologies did CMU get out? “I’m talking about licenses, helping one of our professors publish as an open source, or agreeing to an IIA with another university,” he explains. “They may or may not have commercial inclinations; we are completely aligned with our faculty members.”
The one factual issue he had with Shane’s article was the statement that most universities offer the standard agreement with equity share as a “take it or leave it” deal. “I’m not sure that’s true,” he says.
As a matter of fact, the equity share agreement is not a “take it or leave it” situation at CMU. “We’ve had a standard deal since 1997, but it’s always been an option for faculty if they wanted to take a cash license with an upfront fee,” Wooldridge notes. “Why would we have a problem with that?”
A detailed article on the use of standard equity deals for faculty start-up licenses appears in the October issue of Technology Transfer Tactics. To subscribe and access the full article, as well as TTT’s complete 9-year archive of success strategies and best practices for TTOs, CLICK HERE.