Negotiating technology transfer agreements like a pro
At Extantia, we negotiate investments with founders on a daily basis. We are regularly surprised at how well entrepreneurs these days are well-versed in complex venture capital language and terms. Founders easily incorporate terminology like liquidation preference, anti-dilution, and bad or good leaver events into their lexicons. Over the past decade, a lot has been written about “demystifying the VC Term Sheet”, but for many companies, especially those in the climate tech sector, the contract with a VC will only be the second most important one they sign.
A particular contract precedes any VC investment and is a key part of developing any product based on new research or technology. Despite that, it remains almost undiscussed. It’s called a technology transfer agreement, and it allows founders to bring intellectual property (IP) that was invented in publicly funded universities and institutions to the market.
If you’re a scientist-turning-entrepreneur, and you want to use your own research as a foundation for your business, you’ll need a technology transfer agreement to give you the legal right to this IP. This article is designed to give you practical advice on each of the major terms of technology transfer agreements. It relies on best practices from Extantia’s portfolio founders, legal partners, and team members. Please note that our experience is with deep tech and climate tech companies. The numbers for life Sciences companies may be different.
💡What is a technology transfer and when do you need one?
To secure your IP, you’ll need to approach the university’s Technology Transfer Office (TTO). The TTO is responsible for orchestrating the legal process that allows you to transfer knowledge gained from publicly-funded research into the private market. It’s often used for new inventions and discoveries, and historically has been very common in the technology and pharmaceutical industries. Your university’s TTO can also help you file a patent for your technology. Some universities file patents internally, while others outsource them to a daughter company or external service provider.
When you invent a new technology as a researcher, it’s a technology transfer that gives you the legal right to use it commercially, and whether you’re leaving academia to start up a new company, or wanting to continue doing research while commercialising your inventions on the side, you’ll need to go through this process. Although, if you’re planning on doing the latter, you should be aware that continuing to work at a university while having a financial stake in your product is normally considered a conflict of interest, and may taint your IP (the university can claim a stake in any further development and/or improvement you make while still being primarily employed by the university). If this is your plan, be very careful, because you’ll need to clearly address this in your IP license.
Even if you aren’t yet at the stage where you’re ready to start your own company, it’s good to think about the steps you would take when you reach that point, so that as your research matures, you can benefit from your work and protect your intellectual property.
ℹ️ The ins and outs of licensing
There are several types of technology transfer agreements. Some agreements, such as sponsored research agreements and materials transfer agreements, allow companies to provide resources and funding to research institutions in exchange for the rights to negotiate licenses once the research bears fruit. While this might be useful for researchers looking for a bit more funding, if you are planning to commercialise completed research, it’s likely that you’ll instead want to get a patent or technology license. These are legal agreements that make your involvement in the research clear, allowing you to use the research commercially and gain benefits from it.
When choosing a license, the first thing you should think about is exclusivity. Exclusive licenses mean that only one licensee is allowed to use your technology, while non-exclusive licenses mean that multiple entities can pay you for the license. There are also various types of partially-exclusive licenses, where you can limit licensees to a particular geographical area or branch of technology. For example, if you’re working on medical technology, but know that it could have space applications you don’t want to see explored, you can create a partially-exclusive license that excludes space use.
While it might seem tempting at first to choose a non-exclusive license and cast a wider net, investors strongly prefer exclusive licenses. It reduces competition and creates a clear competitive advantage over the competition. With an exclusive license, a licensee has the potential to be first on the market with new technology — creating a defensible moat, an attractive option for any investor. At Extantia, we only invest in startups that own exclusive licenses.
You should know that even in exclusive license agreements, the university always retains the right to do further research on the basis of the existing know-how. The fate of the results of such further research as well as the confidentiality obligations of the university including specific provisions on scientific publications should be clearly addressed in the agreement.
💶 Equity vs. Royalty
Of all of the transfer agreement terms, the one you should care most about (and universities alike) is how you’re going to pay for the license. While there are many different payment structures, the most common ones are royalties and/or an equity stake in your company. Before we go into the pros and cons of each, here’s a short explanation of both.
Universities and similar institutions typically opt to receive royalties. These are arrangements where these institutions consistently receive a share of the revenue generated by the sale of products and services that make use of the licensed technology. This reduces the amount that you will have to pay upfront and divides the risk between your company and the university. If things go well, the university will receive a consistent share of revenue, but if things go badly, both parties will lose money. This arrangement is attractive for universities because it reduces their risk.
The other option is giving the university equity in your firm, usually by giving the university common shares or a warrant to buy shares. This makes the university one of the parties in the company (“on the captable”), and if successful, universities can stand to gain more revenue from this than from upfront payments or royalties. Most universities do not favour the equity route. This is because universities need to have legal mechanisms in place to hold and manage stakes in a commercial company, something that many smaller universities may not be prepared for. However, while most universities still seem to prefer the royalty route, research suggests that equity is better for universities in the long run.
Among entrepreneurs, though, the question of royalty or equity is a big debate. There is no right or wrong. A lot depends on your company's needs and the individual university. We’ve summarized the most common arguments in the table below, but ultimately, you have to decide what works best for you.
Royalty
Pros
- Payments are predictable. You can prepare your business plan and cost structure to account for this known expenditure.
- Simplified captable. Public institutions are notorious to be slow and hard to work with. Think twice if you want such shareholders. Royalties solve this problem.
Cons
- Royalties lower your profit. If set too high, investors and buyers will lose interest in your business.
- Royalties impact your cash flow. Especially in the early years, you may generate revenue (and thus need to pay royalties) but your business will still make a loss. Paying royalties will exacerbate the cash flow situation (you can try addressing this by implementing a tiered royalty model).
Equity
Pros
- No payments before an exit. For a startup “cash is king”, therefore the ability to postpone the “bills” to a later stage is of great value.
- Alignment of interests. Equity investors have a vested interest in seeing the business succeed, and you can lean on their expertise and connections. For example, you may be able to continue using the university’s facilities which can save you a lot of time and money.
Cons
- Complex captable. Was it hard and time-consuming to negotiate the technology transfer agreement? If the answer is yes, then don’t expect it to be better in the future. Now think carefully if you want a slow complicated shareholder on your captable (AKA deadweight)
- Takes more time. Usually, a royalty-based structure takes less time and effort to negotiate and close.
📖 Common Terms and Best Practices
Here are some of the most common terms used in technology transfer agreements together with best practices from the collective experience of our team members, founders and lawyers.
In this list below we list all options, but your contract may just be a subset of them (e.g. if you only pay royalties and have no equity component). It is important to note that this is not legal advice and all amounts/conditions we mention may vary significantly according to the maturity of the IP (e.g. granted patents are more expensive than just filed patents) and the field of operations (e.g. pharma technology can be way more expensive than climate technology).
Upfront/one-time payment. Payment at the time of closing the contract.
Best practices: between €20k and €50k. This sum hurts the most, so try to keep it low.
Milestone payment. An extra one-time payment that is triggered by time or company achievement.
Best practices: between €50k and €80k. This payment usually comes 3–5 years after closing the contract. See if you can increase this one in favour of reducing the upfront payment.
Maintenance fee. Yearly payment is meant to cover the administration costs of keeping the patent.
Best practices: up to €5k p.a. but may go up over time. We recommend that the maintenance fee should be creditable against any royalties paid (either or mechanism).
Royalties. The main sum paid to the university for licensing the technology.
Best practices: anywhere between 1% to 5% of Net Sales (i.e. minus any packing, insurance, freight, duties or taxes). Try to cap the absolute amount you pay and/or reduce the percentage as Net Sales grow (e.g. 3% to 20M in sales, 2% between 20M and 40M, and 1% above 40M).
Sometimes you can get away with a fixed amount per unit sold, which is naturally better for you (this amount should also decrease as sales go up).
Sublicensing. Fees in case your revenue is generated through the sublicensing of the technology, for example to a distributor.
Best practices: normally 15–20%. As with normal royalties, try to get it down over time and limit it. Also, make sure you’re allowed to sublicense at your own discretion without university permission.
Equity. Shares owned in the company as full or partial replacement of royalty payments.
Best practices: in the range of 5–10% with high variability (we’ve seen 0–15%). As a rule of thumb, if the royalties are low then the equity is higher. Do not agree to more than 10%. This will hinder your ability to raise venture capital money in the future.
Sometimes, the university will not take equity immediately but will ask for an option/warrant to buy the equity in the future. In that case, anti-dilution protection will be introduced. See below.
Anti-dilution protection. In cases of equity ownership, universities want to make sure their shares retain value even as the company grows and raises further rounds (which dilute the universities, since they usually can’t do follow-on investments).
Best practices: you cannot give universities better terms than you give your investors (they don’t have dilution protection against future up rounds). There are many ways to structure anti-dilution (like using warrants). In all of them, the most important thing is to limit the anti-dilution option and set an expiry trigger. It can be a date or amount of money you raise (a low one of course).
Diligence requirements/performance milestones. Universities want to make sure you make use of the technology (so they get royalties and earn money from the technology). Thus, they ask to set milestones (like X amount of sales by year Y). If milestones are not achieved, universities have the right to terminate the contract.
Best practices: set the bar VERY low, so your chances of achieving the milestones are high. The actual number can vary, but make sure that it is achievable. If possible, limit your obligation to commercially reasonable efforts only so you don’t actually have to achieve the milestone, but to prove that you’ve tried. Think well about the metrics ($, tons, units sold, etc.).
Infringement and Litigation. In the case of IP infringement by a 3rd party, who should be in the lead for the prosecution of such infringement and who should get the benefits of such a prosecution?
Best practices: ideally, the company should be in the lead (only then you also bear the costs). If the university is in the lead, make sure that i) you can share the cost so you enjoy any proceeds and ii) that the university cannot settle in any way that is harmful to you. Also, ensure that the university cannot unilaterally decide not to pursue any infringement at all.
Purchase Option. Giving you the option to buy the patent for a lump sum at a later point in time.
Best practices: It is wise to have an option for this in the future, even if you don’t have the money for it now. In that case, you need to agree on a purchase price at the time of the option exercise. The purchase price can massively differ between portfolios of granted patent families (7-digit figure) and pending patents (5-digit figure).
Assignment. Determines whether the company and/or the university are allowed to give the rights under the agreement to another company.
Best practices: this clause may look harmless, but it is the key to your exit. In the process of an exit (or Deemed Liquidation Event as the contracts usually call it), the buyer wants to take ownership of your IP. This would only be possible if you were able to transfer the contract you’re party to the new owner of the company. This is called an assignment. You need to be able to assign the contract in the event of an exit, or (second best) get the university’s consent which must not be unreasonably withheld. Try also to put a time limit on this process otherwise, your exit process may drag on for a while or even be de-facto blocked.
Sometimes the main question in an exit event is not the one of assignability but whether the agreement contains a change of control clause triggering a special termination right (or other harmful consequences) in case of a change in ownership of the majority of the shares. Make sure non of the terms in the agreement can block a future exit.
Termination. Defines the term of the contract and reasons for early termination.
Best practices: be careful not to trigger an early termination. One reason for termination, milestone performance, has already been discussed above. Note that insolvency can also be a reason for termination. Even if insolvency may not be the end of your business (restructuring case), it may jeopardize your main asset, your IP. Late payments can also result in early termination.
📝 Summary
Terms and conditions vary significantly between countries, universities, and research fields. Therefore, this article can only give you a ballpark idea of some of the possibilities and things to look out for. At the end of the day, it is important that you compare apples to apples. Make sure to reach out to founders that span out from the same university as you, ideally those in a similar field of operations. Only then can you get a real picture of your negotiation possibilities.
Also, invest in a legal review of the IP situation at an early stage at least to the degree required for awareness of the main legal obstacles. It is much more expensive to clean up botched IP assignments than to have everything set up right from the beginning.
