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University-Industry Engagement Advisor

LLCs can be smart for university start-ups, but only if you know the risks

By Jesse Schwartz
Published: April 11th, 2018

Faculty start-ups have a few different options when it comes to forming a corporation, and the limited liability corporation (LLC) can be appealing. It has favorable aspects for entrepreneurs and it can be smart for universities that wish to take equity in the company, but there are potential complications to consider before making a decision.

University faculty are not likely to be up on the ins and outs of corporate structures, so tech transfer leaders should be ready to explain the basics and help walk them through the decision making process, says Christopher F. Wright, JD, shareholder with the McCausland Keen & Buckman law firm in Devon, PA. And from the university’s perspective, he stresses, that decision has critical implications that must be thought through in each case.

“It’s really easy for a licensing officer to forget to look at whether this start-up is going to be an LLC or a C-corporation. It’s going to cause significant differences in how that licensing deal is done, so it’s a matter to address up front,” he says. “They don’t think through the tax issues at a macro level. That ball gets dropped a lot.”

Part of the decision will come down to the appetite of the university administration for taking an equity role in start-ups versus only being a licensor, says K. Lance Anderson, JD, an attorney with the Dickinson Wright law firm in Austin, TX, who previously directed the TTO at Texas Tech University. Some universities will settle on a hybrid in which they license the intellectual property but also hold equity in the start-up.

“That sounds good but sometimes it creates additional complexities. Taking a position where you’re a licensor and a shareholder in an LLC means there are inherent conflicts, a potential misalignment of interests. On one hand you’re holding rights on which you can assert a default in the company, but that’s a company in which you’re a partner. You’re kind of fighting against yourself at some point.”

Unlike a straight license agreement, taking an equity position in a start-up also can create a “significant financial interest,” a legal term that can affect the integrity of ongoing research, Anderson notes. “That is a manageable conflict of interest, but in some instances and especially when human subjects are involved, that conflict can be such that you have a real issue,” he cautions. “This can come down to the goals of the administration and the university. Do they feel strongly enough about supporting entrepreneurial efforts to effectively manage these issues?”

Much of the consideration when determining start-up structure from a TTO perspective needs to be tax-driven, Anderson says. When starting any company and looking at the entity choices, the tax considerations are some of the first to consider because they can drive you in one direction or another, he says

There are potential tax benefits as well as risks, but it would be a mistake to assume that an LLC is the right decision for all start-ups, Wright says. In some cases, for example, that structure would complicate the university’s relationship with the business or be detrimental to the university.

“The trend for a number of years has been to do more start-ups as LLCs because you have one level of taxation, private investors may be able to use the passive losses, and a whole host of other reasons,” Wright says. “But most universities have not considered some of the peculiarities for them with doing equity licenses with LLCs rather than a traditional C-corporation. A lot of universities have stepped into an LLC without thinking things through.”

A detailed article on business structure for university start-ups appears in the March issue of Technology Transfer Tactics. To subscribe and access the full article, along with the publication’s nearly 11-year archive of best practices and success strategies for TTOs, CLICK HERE.

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