Spinning Up Spin-Outs

Over the last few months there has been a loud discussion in the media about university spin-outs and their relationships with venture capital providers. OK, your definition of “loud” needs to mean half a dozen or so articles and “media” needs to mean a couple of specialist publications such as Sifted, but if you work in entrepreneurship policy or startup support this can feel like News at Ten levels of exposure. On the whole, we don’t get out much.

The debate was initiated by voices from the VC industry accusing (and that was the tone) the UK university sector of naivety (at best) or greed (at worst) in demanding unrealistic levels of equity holdings in newly formed spin-out companies. Spin-outs are companies based on university research into which universities have placed intellectual property, typically in return for license fees and an equity stake. It’s an area I first worked in around 2001, on the investment side, and for most of the last 20 years I have continued to have an interest in it, from the university side.

The belief underlying this media furore is that there are untold commercial riches lying in our universities that are awaiting discovery and development with the promise of economic wealth for all those involved and new jobs, new industries and new solutions for the nation. But the sector is actually very small, accounting for only a couple of hundred new businesses per year out of nearly 800,000 registered in 2022 (as reported in CFE’s Business Startup Index). Nonetheless, it still excites investors who see the possibilities of outsized returns from radical innovations and politicians looking for economic solutions to pressing national issues.

There has been a long line of reviews and policy activities over the last 20 years to explore these issues, including the very comprehensive Lambert Review of 2003 and the wider landscape outlined by the Sainsbury Review of 2007, which still have relevance to where we are today. The tensions have changed little in that time – just look at the recommendations concerning capital and skilled management in those reports.

The latest contributions include the Labour Party’s “Start-up, Scale-up” report, published late last year. It has a whole chapter on “Universities and Spinouts” and a series of proposals that include a requirement for universities to report more data annually on spinout formation and greater range in the agreements offered to academics looking to form a new business. The recommendations are mostly quite cautious and not far from what is happening already.

The current Conservative government’s play has been a formal review of the spin-out landscape initiated in March this year. It’s narrower in scope, but deeper in intent. (One funny thing to note being that Labour and the Government don’t agree on whether it should be “spin-out” or “spinout”, but I digress and must admit I am not always consistent!)

CFE had conversations early in the process with the team of civil servants from Department for Science, Innovation & Technology (DSIT) and HM Treasury working on the review, who have proven to be a reassuringly well-informed bunch. Our discussions highlighted key nuances that the public discussion had not touched on and, specifically, the need for a wide variety of voices to be heard as part of the process in addition to those that have already pushed themselves above the parapet.

Over the last two weeks we have held two roundtable discussions and some one-to-one interviews to bring those voices in to the conversation. The first was a virtual event, with representatives of the university sector from Scotland to the South West of England. They included some working in technology transfer but also others who work with wider parts of the entrepreneurial landscape such as incubators, accelerators, and student enterprise, who therefore have other experiences and yardsticks by which to evaluate what is happening in the spin-out market.

The second was in-person and focussed on those outside of the university sector, from professional data and policy analysts to those coming from investment players and support providers. The individual conversations have tried to ensure that smaller voices, such as business angels, have also had a chance to be heard.

Over the next week or so, we will be sifting the contributions and synthesising a submission to reflect the wider views of the spin-out market and add some of our own thoughts and creative recommendations.

But there are some first observations that came from the fifteen or so contributors to date that are worth sharing and we would love to hear from anyone with comments.

  • Investors and Universities do not have the same end goals – This should be obvious, but it really is not as straight forward as it sounds. One side asks why universities don’t give more away for less. The other side sees things working for them. The differences can mostly be explained as the parties looking for different things in the first place. The “see it from our side” argument has not led to greater understanding of why anyone is seeking change.
  • Everyone is behaving rationally, given their motivations – Investors want to invest for the best return and are right to be looking for great companies that are as unencumbered as possible. Universities are rightly looking to cover their costs but also have objectives that are not related to direct returns from anyone investment. They can rarely wait five to seven years and only the largest players have any kind of portfolio benefit. But they can use examples of successful companies to improve grant income and that’s a much bigger financial driver. Universities are therefore doing what has been asked of them given the metrics they are measured on. If you want to change the behaviours, we need to change the motivations.
  • Spin-outs are not like most startups and the differences need to be accounted for – With most startups you expect to find an experienced management team with knowledge of a market and they drive the process. Most investors expect this and have processes built around that. But spinouts start with a research team and a capability to so something and mostly that something is deeply technical. These two starting points are significantly different and need different types of support. Applying “standard” investment processes to spinouts is a recipe for disaster. It’s notable that investors who are experienced in this area see fewer reasons to call for radical change.
  • The biggest issue is lack of time – Many TTO’s, in big and small institutions, are short of time given resource constraints. Researchers who want to form a company often underestimate the amount of time it takes to do so and then need to juggle ongoing research and teaching commitments. Dropping those completely can remove one of the long-term benefits of working with a spinout in the first place, so more support and external management are needed. We need to be able to invest more in the early stages, not less, and that will need to be paid for in the return to the TTO or more equity going to external managers.
  • The second biggest issue is lack of capital – For all small companies in the UK, particularly those in deep-tech areas, there is general agreement that there is a lack of risk-taking capital. This is something widely acknowledged but the impact on the spin-out sector is amplified by the nature of the businesses. The number of spinouts is small relative to the overall startup sector. This needs fixing for everyone.
  • Remember your history – I am an historian by training and perhaps that is unhelpful bias, but I really do think we need to look at what has happened before. There are reasons why this market is the way it is. We didn’t end up here by change and it’s not like a good number of clever people haven’t looked at this (many) times before. That suggests strongly that the problems are hard to solve. It alarmed me to see how short the collective memories were among the groups we have engaged with. Important past interventions to move this market forward, like University Challenge Funds, have been lost from a lot of corporate memories. Many of the ideas on the table have been tried before. Changing circumstances mean they might work better now but we really should be looking at the reasons for past successes and failures for interventions before we implement them again. Stupidity can be defined as trying the same thing twice and expecting a different outcome. Let’s be better than that.

If you would like to comment on this topic please email info@centreforentrepreneurs.org