ipstrategy.com http://ipstrategy.com/2013/01/31/why-universities-are-the-worst-shareholders-for-spin-out-companies/ Why Universities are the Worst Shareholders for Spin- out Companies By Ian A. Maxwell This article is written in the context of the Australian environment but many of the conclusions are quite general. Background Over the last 20 years much more money has gone into global venture capital sectors than has come out. This unprof itable imbalance seems improbable and only exists because of the long and illiquid investment cycle of venture capital that has prevented market f orces f rom properly correcting this oversupply of capital. Venture capital returns in Australia have been particularly bad; a result of many f actors but primarily the causes can be tracked back to an unreliable source of high quality investment opportunities, especially f rom the Australian university sector. The result is this: technology companies that spin-out f rom Australian universities, when measured collectively as an investment class, are wildly unprof itable f or investors. This helps explains why Australian superannuation f unds have almost totally withdrawn their investment support f or the Australian Venture Capital sector. From a university perspective, the more shareholdings in spin-out companies that a university owns, the more likely it will ‘regress to the mean’ and end up with a negative f inancial return. The return is negative because, on average, university shares in spin-out companies end up being near to worthless (either because the companies f ail or the common stock held by the university is not ‘in the money’) but there is a real cost to spinning-out start-ups and owning shares in them. Universities of ten invest cash and in- kind resources into spin-out companies in order to get their shares and the cost of owning and managing shares in a spin-out company is relatively high f or universities since, unlike venture capitalists, being a start-up shareholder isn’t their core business so they use a lot of external legal and IP consultants f or these purposes, as well as f unding their own commercialisation group whose job, amongst other things, is to manage shareholdings in spin-out companies. Despite rarely getting a f inancial return f rom spin-out companies, there are very good reasons why universities should sometimes actively spin-out start-ups. Firstly, genuinely great technology which can benef it mankind is sometimes best propagated via a spin-out company – along with licensing to corporations it is one of the two great models for ensuring investment into a university technology concept. Secondly, spin-out companies can be great marketing opportunities f or universities, helping to attract f unding and high quality students and staf f . Thirdly, spin-out companies can have a positive f eedback ef f ect f or a university where researchers become more f ocused on lucrative emerging technology areas due to interactions with the spin-out companies. I would argue that none of these three benef its are enhanced by a university owning shares in spin-out start-ups. These benef its can all be achieved by licencing technology to spin-out companies with no equity position, which is a much lower-cost and lower-risk process for a university. The Problem with University Shareholdings in Start-Ups Without the ability to invest in every investment round, from foundation though to the ‘exit’ of a start-up, a university as a f ounding shareholder of a start-up is even f urther guaranteed not to get a f inancial return from shares, often even if the start-up ends up being successful. This is because many start-ups, along their journey, have a dif f icult round of f unding, sometime called a down-round, when the company is re-priced (downwards) and shareholders not contributing f resh investment f unds get diluted and also lose prior shareholding rights (such as liquidation pref erences and board representation); this is why