A First Principles Take on Commercialisation
Universities are and have been the nucleus to our knowledge economy for decades, yet nominal progress has been made by government in understanding how to optimise their value chain. In every three-year election cycle I am wastefully reminded that funding public university institutions in bulk is the answer to our commercialisation woes and overcoming the so called ‘valley of death.’ Yet this rhetoric continues to play out and fall short of anything material, why?
But the problem isn’t that we lack capital, it’s rather rooted in its allocation.
So instead, I’m going to provide a different angle to the discussion and dive deeper into incentives.
The tech transfer office value chain 🔗
There are 43 universities in Australia, and they’re quite an ambidextrous bunch, or rather expected to be. To attract the best talent, long-term partnerships and federal funding, universities over time have looked for more ways to remain competitive by dialing up their impact on policy, community health, wealth and job creation. This perpetual search for revenue diversification has lead many, if not all universities, to increasingly prioritise a large subset of their knowledge systems — technology transfer.
The technology transfer offices (TTO) are the structural body behind this and whilst their model can vary substantially, have traditionally been responsible for three core activities:
- Process invention disclosures
- Commercial viability of invention
- Develop suitable path for commercialisation (Licensing or spin-out).
TTO’s have traditionally preferred to license their intellectual property rights to a corporate (licensee) in exchange for royalty and/or equity.
The last couple of years have seen expectations rise as TTOs look to recoup the revenue shortfalls of the pandemic-led crisis in higher education and continued underperformance on a global scale. Now with the recent federal stimulus, they face even more pressure to transform intellectual property into commercial diamonds and make significant headway in reversing the ‘passion project’ rhetoric.
Competing with the demands of academic and commercial domains in a rapidly diversifying system, TTO’s certainly might feel as though they need to produce the next unicorn & be a profit machine to even warrant further support from government.
The problem is that universities aren’t natural capital allocators and their internal incentives proscribe any chance that they could be.
Out-dated incentives 🚫
Universities are essentially structured in the following way. Publication output determines global rankings, and rankings in turn dictate the extent of revenue that can be generated from international student enrolments. This system only incentivises universities to pump out research and maximise the h-index , keeping academics and fellows trapped within this self fulfilling prophecy.
So expecting such an institution to diversify into a domain with limited consistency and alignment is like expecting a homeless person to invest that 100 dollars you gave them into the S&P 500. He or she isn’t incentivised by the long term, they just want to light a cigarette.
My point is, before we continue to project unrealistic expectations on universities in domains they can’t effectively excel in, our government first needs to realign themselves using first principles. That is, encouraging a system that actually motivates universities to flex their commercial muscle, instead of writing large cheques once every couple years that solve nothing.
Motivating Uni’s to flex their commercial muscle 🦾
1. Creating a National TTO
Universities and governments have a vested interest in optimising the economic externalities of university research. Therefore creating a national TTO that serves all universities would create broader commercial incentives that go beyond protection of IP and inward looking incentives of institutional TTO’s.
Instead of less commercial metrics such as No. of invention disclosures or licenses/assignments, a national TTO can institute metrics that encourage long term industry collaboration. No. of exits/ annual research expenditure or No. rounds of external financing/ Licensees/assignments or spin outs are an example.
Between 2004 and 2013, the University of Queensland’s TTO Uniquest was contracted to perform the TTO activities for four over capacitated universities : James Cook, University of Tasmania, University of technology and University of Wollongong. This ‘hub and spoke’ model was intended to bolster economies of scale, expand global reach and a more nationally incentivised TTO. In theory, the four under - resourced universities would benefit from the network, track-record of the more established Uniquest whilst Uniquest would be able to strengthen their output and capitalise on under commercialised inventions.
The short fall of this study however was two-fold. One, the partnership behaved as a dependency rather than a decentralised tech transfer office. Two, there was no investigation on commercial revenue, equity and license income due to benefits being ‘sporadic’ and ‘occurring in the long run.
Yet there are several things that showcase the benefits of a more ‘established’ TTO:
- Significantly outperformed the benchmark, elevated UQ to top ten percent of universities globally in commercialisation output
- Increased impact and maximised national benefit
- Sharp increase in invention disclosures and provisional applications
- Leverage synergies between universities and pooling resources
2. Flexible “equity ceiling”
A flexible equity ceiling of ~10% for university ownership can be an effective compromise for universities looking for long term value creation but not at the expense of the founders’ motivation.
Just the other day, a founder sent me his pitch deck looking to raise his first round of external financing.
He had already been diluted over 30% by the University TTO.
Given the mean % dilution by the third external round is often ~40%, are spin out founders left with too little ownership % and sub-par economic terms to spin out?
Since 2017 the number of new licenses and spin outs have increased by c.6% and c.29% respectively. Yet in the same time, the percentage equity (%) held by Universities have increased by c.60% YoY or 4.5x . This is a significant step change from what was observed pre-Covid and it signals a clear intent by universities to have greater skin in the game and influence on longer-term industry outcomes.
But given we currently stand 40th globally in commercial output that’s only marginally better than New Zealand’s, are universities and founders caught in a catch-22?
This creates even more difficulty in attracting investment from downstream investors, especially when the risk you’re trying to resolve is the governance itself. Having at times slower and more bureaucratic institutions by nature as larger shareholders can at times create unnecessary friction and sway generalist investors from ground-breaking companies.
How the UK & US have attempted to break the cycle
We can certainly learn from the larger & more developed university ecosystems in both the US & UK. Two of their top institutions provide great examples of founder friendly license/spin-out terms.
Typical upfront fee is waived in lieu of grant of a fixed 10% equity in startup. Yale effectively receives 5% equity.
‘Founders choice’ allows researcher to tailor the terms to cater for the diversity of IP. Two options are “Founder Driven Route” and “Jointly Driven Route”. University founding equity is 5% — 10% and is undiluted up to a cumulative investment cap between $3 and $15m.
Either way, government should look to position a cap on how large a stake Universities can take in spinouts and licensed IP no matter how much “value” the University believes to bring to the cap table. If we can encourage these institutions to see the long term benefit of being a minor rather than active significant, we might be on our way out of this catch-22.
Going from here 🚀
Whichever way you look at it, the sole business goal of the TTO is to create impact, but impact shouldn’t necessarily be constrained to profit and quoting billion dollar market value spin-outs. Rather, their job sits in the broader domains of impact : to harbour knowledge exchange, attract top talent and promote excellence in education and innovation. Australian Universities rank 9th in knowledge creation worldwide!
As long as we have university accelerators and anchor funds willing to invest in early R&D and de-risk these frontier opportunities for downstream investors, universities can prioritise their energy into doing something they are both brilliant at and effectively incentivised. For now at least.