Angle, a venture capital firm specialising in technology, signed a 20-year strategic partnership with the University of Reading that will give the company the exclusive right of first refusal to invest in all university intellectual property (IP) that is commercialised. Where it exercises this right, it will be able to take an equity stake of 60% in each spin-out company for an investment of up to £0.5m. Additionally, Angle will receive a 15% share in all commercial returns from IP, both licensing and spin-out, in which it does not invest. In exchange, it will provide consultancy support to the university on IP commercialisation. At least £3m is expected to be invested over the first five years of the agreement.
Quester, a UK-based private equity firm, has a long-established track record in the university spin-outs space. It recently launched its fourth University Challenge fund, which reached a first closing of £5m in July. Called Isis College Fund II, it continues the strategy of its predecessor by investing in companies that are based on Oxford University technology.
Though Europe’s university spin-out market is developing at a pace, it is still difficult to recruit experienced managers for such small companies. So savvy private equity firms are taking it upon themselves to provide management and the idea seems to be working.
Quester has its own management initiative. QED, or Quester Enterprise Director programme, is a network of individuals focused on identifying spin-out opportunities from the universities in which Quester manages seed funds and helps to get those companies established. Simon Acland, a managing director at Quester said: “We try to be reasonably selective in how we invest, but we can’t apply the same criteria we do for our later stage funds otherwise we would never invest in anything, but we have to widen the filter somewhat and invest in companies that have real commercial potential.”
Generally, when VCs look to put money into spin-outs, they check two things: is the management any good, and do they have a good business plan. The latter often relies on the former, and the presence of good management relies a lot on whether the company can attract money.
MTI, a Watford-headquartered private equity firm has also completed deals that have originated out of universities – ApaTech for example, a company built around technology developed at Queen Mary University of London that was created in 2001 with an investment by 3i. MTI led a funding round in April 2004.
Ernie Richardson, CEO of MTI, said: “There is still an issue about how you translate that into a business.” And Andrew Newland, chief executive of Angle, said: “The UK is a really good engine for creating science and we punch well above our weight in a global sense, but we aren’t very good at exploiting that due to a lack of good management in the early stage of the commercialisation process.”
The reason university spin-outs have such trouble is because they don’t have the money necessary in order to pay managers high salaries. Some managers are willing to forego a salary in return for a strong equity stake. “But these people want to see a good commercial proposition”, says Newland, “and this often doesn’t exist. Because they can’t get good management in, these companies have bad management from the beginning, so the opportunity isn’t exploited.”
Angle’s solution, like Questers, is to hire the managers themselves, picked on the basis of their industry experience and commercial expertise, pays their wages and puts them to work turning good intellectual property into commercial enterprises. By performing such a role, they are increasing the chances of the company receiving venture funding.
However, there is some difference of opinion among venture capitalists over who should be hiring these managers. The BVCA report ‘Creating Success from University Spin-outs’, argued it should be the job of the technology transfer offices (TTOs), but should this really be done by the VCs, as they are the ones that are going to commercialise the business and supposedly have the business sense. Acland said: “I think it is incumbent upon any investor to bring in the right management, and venture capitalists are better placed to install managers than the technology transfer offices. It is very important that VC investors see this as their role. According to the BVCA report, TTOs said they found it harder to recruit managers than money.”
Acland thinks there has been a shift in the way that VCs and universities are working together: “When we started working with them in 1999/2000 there was a cultural divide. I think the universities and the professors thought the VCs were out to grab their IP rights and run away with the money. They now understand what each other can bring and they also both understand the third essential ingredient of management.”
The good news
The future for university spin-outs looks broadly positive. The right ingredients are certainly there, the challenge is bringing them together, and there are some signs that this is happening. For example, in November last year the University Companies Association (UNICO) found that total licensing income rose from £31.3m in 2003 to over £40m in 2004, with the number of licence agreements more than doubling during this period. From 2003 to 2005, 20 spin-outs from UK universities have floated with a combined value of over £1bn. UNICO also found that 35% of the spin-outs established in 2004 raised external investment finance, indicating that universities are doing a better job of creating investment-ready venture attractive to the investment community. Southampton University came to a similar conclusion with research it released in June this year, which said that 26 university spin-outs have floated in the past three years, with a combined value of £1.3bn.
The IPO of Imperial Innovations has also bolstered industry feeling. The technology commercialisation company owned by Imperial College London raised £25m after floating on AIM in July, and at the time of writing had a market capitalisation of £191m, up from the £100m on IPO. It was the first and so far only flotation of a majority university-owned technology transfer company in the UK.
Richardson said there is a more optimistic belief around the spin-out world nowadays: “In the last 12 months the whole seed to early stage space has come of age. The IP2IPO initiative [the IP Group has IP deals with eight universities across the UK], the Imperial float, even hedge funds are getting into this space. What these are indicative of is a market that was a kind of cottage industry a few years ago emerging as a serious sector.”
The false funding gap
The funding gap has for years been regarded as almost immovable by early-stage technology companies and the major reason why start-ups and university spin-outs in the UK struggle so bitterly to raise money. But as an excuse, this is looking more and more flimsy based on an increasing body of evidence that the funding gap is a myth. It may once have existed, but no longer, according to Library House, a London-based venture capital research firm, along with numerous early-stage investors.
Library House, which is headed by former Dragon’s Den star Doug Richard, released a report over the summer arguing that more deals took place in the so-called ‘equity gap’, defined as companies requiring between £250,000 and £2m, than any other value bracket. Richard said: “This now begs the question that if there is no gap, is government policy, which is channelling significant amounts of public money into funds, the right way to support entrepreneurs? The issue that the UK confronts is not an equity gap – it’s a readiness gap. Companies fail to raise investment because they are not attractive enough to the investors, not because the money is not there in the first place.”