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As IPO market booms, should universities be managing their equity stakes?

This article appeared in the September 2015 issue of Technology Transfer Tactics. Click here for a free sample issue or click here to subscribe.

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Technology transfer offices eyeing the IPO market may wish they could stay involved with more of their start-ups through the initial public offering phase and beyond — and thereby reap far greater financial benefits than they do by simply selling off equity at the first opportunity.

Although it might make sense from a strictly financial standpoint, they probably cannot. For one thing, becoming a stockholder after exit is not what the TTO is set up and expected to do; for another, university policy usually dictates otherwise. That’s why so many universities simply dump their equity at the IPO and let their innovators decide what to do with the money themselves.

That’s the case at Houghton-based Michigan Technology University, where Jim Baker, PhD, is executive director for innovation and industry engagement. “We do not have a formal written policy,” he reports, “but our practice is to liquidate the equity as soon as possible. Generally, we can monetize when the equity is tradeable on the open market, but there are some circumstances when we can transfer our equity to others in consideration of a one-time payment.” As is the case with most matters, he adds, the best option “is dependent on the specifics of a given case.” As a general principle, he explains, the university “will liquidate as early as responsibly possible, which is often as early as technically possible. We disburse the cash after liquidation, and if any one of the disbursees wishes to retain an equity stake, he or she can acquire equity with the cash received from us.”

Other TTOs pursue much the same path, for much the same reason. “For a few reasons, the University of California takes a formulaic approach to selling equity in licensed start-ups that go public,” says David Gibbons, PE, MBA, assistant director for physical sciences licensing in the TTO at the University of California at San Diego. “Our equity holdings are maintained by the UC Treasurer’s Office, along with several billion dollars’ worth of other equity, so the stock is not actively managed given its minute contribution to the overall portfolio.” Also, he adds, “the campus licensing officers may be privy to inside information about the company that could influence the decision to hold or sell the equity. As such, the equity is managed at arm’s length to avoid conflicts. The result is that most equity is sold according to a pre-set calendar, regardless of market factors.”

J. Cale Lennon III, PhD, MBA, CLP, director of licensing in the Office of Technology Transfer at Emory University in Atlanta, reports that equity from licensing to start-ups there is distributed under the university’s IP policy. Emory contributors, founders, and personnel can receive equity pursuant to certain policies and approvals, he says, but Emory personnel cannot receive equity as both a contributor and a founder. The school, Lennon notes, “has no policy requiring equity to be sold at IPO, at the end of lock-up-periods or at other such milestone.” Rather, Emory’s Investment Office manages equity and makes sell decisions on a case-by-case basis.

The rule of thumb at Brigham Young University, in Provo, Utah, is to “sell equity as soon as it can after a liquidating event,” reports G. Michael Alder, drector or technology transfer there. “We have no options to sell stock until there is a merger, acquisition or IPO,” he adds, noting as well that “we have had 10% — three out of 30 — of our equity holdings become liquid in the last 10 years and have recently begun following the University of Utah’s method of taking a negotiated percent of an exit amount that is non-dilutable.” The result, he adds, is “we have recently enjoyed more revenue from our equity holdings than from royalties.”

There is a specific policy at The Rockefeller University in New York City, notes Kathleen A. Denis, PhD, CLP, associate vice president in the Office of Technology Transfer. Within the school’s Intellectual Property Policy is this notification: “Any equity derived from a license transaction will be held by the university and managed by the university’s Office of Technology Transfer or its designee. Such equity will be liquidated as soon as reasonably practicable.” Specifically, the policy adds, “It is the policy of the university to liquidate equity as soon as reasonably practicable, usually in the public market, rather than seek to maximize the return on the equity by trying to time the sale of the equity. The university does not act as a fiduciary for any inventor or author concerning such equity, and no inventor or author will have any right to vote or direct the disposition of such equity.”

Rockefeller’s policy also points out that “the university has no obligation or duty to an inventor or author regarding the value realized upon liquidation of such equity, or regarding any personal tax consequences that may arise as a result of an inventor’s or author’s receipt of net proceeds from the disposition of such equity. Once the equity is liquidated, the proceeds will be treated as cash proceeds and distributed under the terms of this policy.”

Inventor relations drives equity rules

Inventor relations constitute of major component of schools’ approach to monetizing equity. “There is nothing in the Johns Hopkins University policy stating when liquidation should occur,” notes consultant Wesley D. Blakeslee, JD, CLP, a principal at Blakeslee LLC and former executive director at Johns Hopkins Technology Transfer, “but we followed the practice that most universities follow, which is you liquidate the technology at the earliest opportunity.”

The primary reason, he says, is “unless you have the expertise to make a decision as to whether holding on to the investment is a good idea, it’s hard to justify doing that. Remember, in the university space, there are various constituencies that have an ownership of the income stream. When you liquidate the stock, the money goes to lots of different people, including the lion’s share going to the inventor. (JHU gives 35% to the inventors, 15% to the inventors’ research budgets and 50% to university accounts.) It’s hard to justify holding onto the piece that would be distributed to the individual inventors. Do you really want to be in the position of making investment decisions for others?” Faculty have raised the issue, he notes, asking, “Why don’t you hold onto the stock?” His reply, he adds: “I say, ‘When you get paid, go buy it. Then it’s your choice, not mine.’”

It seems like every five years or so there’s talk about doing things differently, Blakeslee notes. “Universities today want to get the big hit,” he explains. “But what it boils down to is it’s simply an investment in a company no different from any other investment. The concern is you’re investing other people’s money.”

If a university maintains a policy of liquidating as early as possible, and follows that policy every time, “it’s hard for someone to criticize you if the start-up stock goes up. They could have purchased stock in the company if they wanted to.” Some schools, he adds, distribute stock to faculty members, while others hold all the stock then distribute the cash upon liquidation. “I like holding the stock and distributing the cash better,” Blakeslee states. “If I were advising somebody to do it, that’s the way I’d advise to do it.”

Few universities, he continues, have the deal volume to merit in-house expertise. “You’re lucky to have one company every five years stay around long enough to go to an IPO,” he says, “and that’s at big offices like Johns Hopkins.” Some schools may have their own internal venture capital funds and their own internal expertise; they often make case-by-case decisions. “If you’re going to do that, you have to have that expertise in investing in early-stage companies,” Blakeslee comments.

He emphasizes: “There are so many moving parts if you decide to hold the stock after a liquidation event, so many things to think about. If you get a Google or Microsoft or an Amazon, it’s amazing. But for every one of those, there are dozens that are gone.”

Attorneys weigh in

The attorneys who advise TTOs generally agree. Louis R. Dienes is a corporate attorney in Ballard Spahr’s Los Angeles and San Diego offices who’s represented universities and university-based start-ups for more than 20 years. “Universities generally dispose of equity stakes at the earliest possible opportunity,” he says. “They are not in the business of speculating on stocks, and technology licensing offices generally do not have the staffing to evaluate the risks and rewards of selling immediately versus holding an investment to see if there will be further appreciation.”

Other than public offerings, the most common way for universities to monetize their equity is through a merger or acquisition of the start-up, he adds, “although IPOs generally result in higher returns to equity holders.” Universities, he points out, “rarely control the decision of whether to monetize their equity in a start-up through an IPO or M&A transaction. The decision is generally controlled by the company and is driven by available opportunities: Strategic competitors interested in acquiring the start-up will often emerge earlier than the ideal opportunity for the start-up to go public, which is dependent not only on the success of the start-up’s business but also the uncertain conditions of the financial markets for an IPO.”

Dienes’ colleague, Scott D. Marty, JD, PhD, in Ballard Spahr LLP’s Atlanta office, adds that “different institutions have different policies; for example, some institutions limit the amount of equity the institution can take, but the more common approach is how long the institution can keep said equity.” Some institutions, he comments, have a mandate to convert the equity into liquid assets that can be distributed according to the institution’s additional policies, while others can hold on to equity and use their best judgment on when to convert the equity and cash out.

“I have seen more institutions change or attempt to change their policies to allow them to hold on to the equity and to take an active role in the administration of the start-ups in an effort to maximize their value,” he says. “I don’t think there is a one-size-fits-all approach. I’d like to think that an institution would always find a way to maximize the value of its equity stake, but sometimes it is about maximizing shots on goal. In other words, equitizing one opportunity may allow for an investment in two others.”

The policy you operate under is likely a difficult one to change, notes Christopher F. Wright, a partner at McCausland Keen &Buckman, in Radnor PA. “Changing it is usually a huge political football,” he says, “and the process often takes longer than you hope. An equity policy gets snarled in thorny political issues around the university’s IP policy.” The two — IP policy and IPO policy — are “usually connected,” he adds, “because the reason the equity is there in the first place is some IP is being licensed.”

One of the reasons so many of the policies in place direct universities to sell as quickly as possible is the fact that if the university holds all the equity, it has a duty to maximizeits value on the behalf of the PIs. “That’s why universities like to have an equity policy,” Wright explains. “You as the PI get your share of the proceeds. If you want to, you can reinvest in the company on your own. That’s one way to look at it. But I’ve also seen situations where the university requires a waiver signed by PIs saying, “We’re holding it for you, but we don’t have any responsibility to maximize its value.”

Potential for insider trading charges

One of the tricky issues, Wright continues, is who makes the decision on when to sell when the university attempts to manage equity on behalf of its inventors. “The TTO has an ongoing relationship with most of its license portfolio companies,” he says, “so people in the TTO may have confidential information, and that can run afoul of the insider trading prohibitions in the securities laws. If the university knows the progress, say, of a drug company whose shares it is selling, there may be claims later that you had inside information when you sold the shares.”

A “safe harbor” in the securities laws, he adds, is a requirement to have a policy in place to keep staff inside organization with access to inside information away from decision making on when to sell. “You need policy, as opposed to practice,” he emphasizes.

Chances are, selling at the first opportunity with an IPO will cost the university and its inventors big dollars on occasion, but that’s just the nature of tech transfer and its role as a force for commercialization, not a force for reaping financial windfalls.

“How you handle equity depends on the university’s stomach for being risk-taking investors as opposed to a more conservative play, which is getting the money in the door,” says Wright’s colleague at McCausland Bob Mascioli, who often handles transactions where equity is involved for TTOs.

“While TTOs may point to the financial successes achieved by really strong TTOs at universities like Wisconsin, Florida, MIT and Stanford, what’s most important to the university isn’t so much the maximization of financial returns as it is the fact that commercializing technology — and the resulting positive increase in reputation the university may achieve for actually getting home-grown technology and inventions out the door and into industry. That helps universities better recruit for highly-considered professors and bring in more research dollars they can use to enhance campus infrastructure and offerings to students and faculty to allow them to do what they do best… build campuses and educate students.”

Universities, he adds, generally know ahead of time what they’re going to do with the revenue from liquidating equity, and most “don’t have the tolerance for playing the market. I don’t see them changing that.” A school could hire or utilize a portfolio manager, perhaps, but “most universities that fall within the range of $80 million to $200 million in annual research funding are not equipped to add that line item to their budget. And the ones at the top of the list already hire outside consultants to manage their endowments. But it’s not like most universities have 50 viable equity positions at a time where they can dedicate a professional to follow the market and manage just their licensee equity portfolio. Only the really top TTOs that have enough out there would need someone — and they likely have enough in-house resources to handle it.”

A middle ground

There’s something of a middle ground available to universities that prefer not to be tied to one extreme – sell equity ASAP or manage it for maximum return — or the other. Christopher A. Marlett is co-founder of and CEO at MDB Capital Group, Dallas. He’s a fan of maximizing equity, but he understands why most schools don’t do it. “You have folks in the technology transfer community who are trying to take a more thoughtful approach, trying to figure out what works better,” he says. “But they have to remember their mandate is not to make money. It’s to enable inventions to come to market and, I think secondarily, to bring commerce to the local community.”

In addition, he concedes, “fewer than 5% of TTOs actually pay for themselves, so they’re always under budgetary pressure. That’s probably the primary reason they cash out as soon as possible. Otherwise, they don’t know when to exit because for the most part, they don’t have the discipline or the mechanism — and the easiest way to not have to make a decision is to say, ‘Sell it as soon as it can be sold.’”

But he prefers “a discipline of selling a percentage of the equity in a specified period, say, selling 10% every six months. That would generally be a more thoughtful approach to it.”

That’s not likely to be adopted at very many schools, Marlett acknowledges. But he does have advice for universities that want to give it a shot. “It’s very difficult for TTOs to take any approach that’s not programmatic, that will involve someone having to make the decision,” he explains. “Who makes that decision? Who’s responsible? If they’re going to hand over that decision, it should be to the entity that manages their endowment or perhaps someone who specializes in that area of technology — at least someone with some capability to make that decision. My sense is what will probably be best for the university and the companies is to take the longer-term approach and sell some percentage over a longer period of time.”

He adds: “That would also balance any fluctuations that occur. One of the problems with selling when you can first sell is the lockup affects everybody and stock prices bottom out at the end of it. It’s really not a good time to sell if you look at it historically. Generally, everybody’s coming off lock up and everybody wants to get out. The market anticipates that, so after the lockup expiration passes, generally stocks do better.”

Time for policy development

Though he’d like to see universities manage equity in a more balanced way, Marlett’s main advice regarding equity monetization is this reminder: “Ultimately, it’s either trust somebody who understands the securities you’re dealing with, or come up with a policy.”

If you take the adopt-a-policy route, Wright adds, do it now. “It’s time,” he says, “if you haven’t already. Most school are doing more and more equity deals in the economic development component of the overall tech transfer function. If you haven’t put a policy in place, do so now. Talk through the issues and make some decisions. Then from a publicity standpoint you can tell PIs that you have a policy and you’re sticking to it.”

Although the decision of whether to monetize equity in start-ups through an IPO or M&A transaction is rarely in the university’s hands, “there are substantial legal protections available to equity holders who know what to ask for,” Dienes points out, “many with cute names — tag-alongs, drag-alongs, piggy-backs, rights of first refusal. It is important that universities engage experienced legal counsel when negotiating their equity rights in start-ups.”

In addition, Baker advises, “be careful to manage expectations, timelines and outcomes so that everyone knows where things are and are likely to go. Also, it is very important when holding equity that’s subject to disbursement to parties — such as inventors — that the university work closely with legal counsel so it does not act as a broker or conduct other activities for which it does not hold a proper license.”

Lennon adds that “accepting and managing equity requires time and effort post-license, it requires communication with other internal stakeholders and it requires clear roles and responsibilities with internal offices such as Finance and Investments.”

Contact Baker at 906-487-2228 or jrbaker@mtu.edu; Gibbons at 858-534-0175 or dgibbons@ucsd.edu; Lennon at 404-712-4758 or jlennon@emory.edu; Alder at 801-422-6266 or mike_alder@byu.edu; Denis at 212-327-8266 or denisk@rockefeller.edu; Blakeslee at wes@wesblakeslee.com; Dienes at 424-204-4347 or dienesl@ballardspahr.com; Marty at 678-420-9408 or martys@ballardspahr.com; Wright and Mascioli via Karen McKay at kmckay@mkbattorneys.com; and Marlett at 310-526-5005 or m@mdb.com.


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