From time to time the idea of introducing anti-dilution provisions into university spin-out company shareholder agreements re-emerges for discussion.
When the idea that universities could have special ‘golden’ shares in spin-outs from their universities was first proposed many years ago, the practicalities were challenged by some seasoned investors, as no special provisions would survive further rounds of investment.
However, the idea has recently been revived by some influential UK based investors and other commentators as being a potential solution to solve problems that they see are holding back the formation of technology companies in the UK namely:
- that UK universities take too much equity in spin-outs and more equity should be retained by founding entrepreneurs to incentivise them to carry out this type of activity
- that negotiations between universities, founders and investors around equity and IP (which are often linked) take too long and this may be limiting the numbers of start-ups being created
As one experienced investor and advocate for this model explains: “The real idea is to maximise the number of spinouts formed and not maximise what the universities get for the IP. My argument is they will make more money since there will be so many more companies formed.” As such, it is worth exploring the idea and issues raised.
What is anti-dilution and what form do anti-dilution dilution provisions typically take?
Anti-dilution is the idea that a shareholder, in this case the university in the context of a university spin-out company, has a special class of shareholding and special interest in the company. The university’s shares are special because they are not diluted by future rounds of investment until a predefined event occurs. There are many forms by which an anti-dilution mechanism can be implemented.
‘Get topped up as you go’
Issue to the university some more shares to bring it up to the previous (founding) level whenever new shares are issued or at the end of a defined event (e.g. Series A financing)
‘Option to top yourself up later’
An option for the university to acquire/buy new shares at pre-set value on the pre-defined financing event occurring
‘Future one-off cash payment instead of shares’
A pre-agreed one-off payment under the licence agreement that is linked to an exit or acquisition of the spin-out – e.g. a fixed payment of £Xm or an amount equivalent to X% of issued shares/acquisition value etc.
The first two models above have become common in some US universities and typically take the form of 5-20% founding equity stakes with anti-dilution to the end of Series A investment (typically defined via a pre-set valuation on the value of the university equity being reached or by a capped sum of money raised).
Most recently a new model around perpetual anti-dilution in the form of a ‘Golden Share’ has been proposed.
The Golden Share idea
The Golden Share idea is similar to the above models except that the equity stake is much smaller in return for enjoying anti-dilution over a longer time period through to an exit or value realisation event. One way the proposal can be expressed is along these lines: ‘the Golden Share shall carry no rights, but in the event of a distribution of assets on a liquidation or return of capital, a share sale, an asset sale or an IPO (with appropriate definitions of these events) the holder of the Golden Share shall be entitled to an amount equal to a set percentage of the Net Proceeds in priority to any other class of share’.
The percentage is set at the start of the company’s life. Advocates of the scheme have suggested that the Golden Share for the university should be equivalent to 1% of the company upon foundation with an additional 1% being non-contractually promised in the form of a philanthropic gift back from a grateful founder/alumnus in the future
It is acknowledged that more could be done to speed up the formation of spin-out companies and that this requires the active engagement of TTOs, founders and investors. In this way the golden share proposal may be welcomed insofar as it is a new idea, but one with uncertain benefits and insurmountable practical challenges.
What is really needed is some evidence based proposals and decision making that involves all interested parties. Without this, it would be a brave step to introduce the golden share idea without a clear understanding of circumstances under which it may work, and how it addresses the problem at which it is aimed.
Tom Hockaday is CEO at Isis Innovation ltd. Tony Hickson is managing director for technology transfer at Imperial Innovations plc.
Further information & next steps
www.imperialinnovations.co.uk/technology-transfer/documents/golden-share/
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