From uni to unicorn: UK university spinouts need bigger incentives to grow
One the biggest biotech listings in years, Oxford Nanopore was valued at £3.4 billion (about $4.6 billion) when it joined the London Stock Exchange in September. Less than a year before, Graphcore, a University of Bristol spinout that creates processors for AI, reached a $2.77 billion valuation after raising $222 million. But these are more the exception than the norm.
More academics and students in the UK are developing an entrepreneurial mindset, but investors say that spinout founders need to own more equity in order to reach unicorn success.
“There’s definitely a cultural shift happening in the UK,” said Jamie Macfarlane, CEO and founder of spinout-focused investor Creator Fund. “We’re starting to move away from the mindset that universities are just places where you spend three years studying. They’re becoming a place where potential founders can explore and exchange ideas and create innovative companies.”
VCs are becoming more comfortable backing spinouts, particularly in areas like deep tech. According to research from fund manager Parkwalk and data provider Beauhurst, some £2.5 billion was raised by UK spinouts last year—a 66.7% increase from 2020.
But despite this increase, and the fact that the UK is home to four of the top 10 universities globally according to QS’ World University Rankings 2021, few unicorns from the country have been spun out from these institutions compared with other countries like the US.
“[There’s a] structural imbalance between founder versus university ownership from day one that makes founders own too little of their company before they’re able to reach unicorn status,” Air Street Capital founder and general partner Nathan Benaich said. “We see too many founders who turn away from founding a company because the process of doing so and the economic terms are a significant deterrent.”
According to research published by the Royal Academy of Engineering (RAE) and Beauhurst, for spinouts where university entities own less than 50% of the company, the mean stake taken in the year of spinning out is 22%. But there are still some that take over 50%.
Spinout founders having smaller stakes also presents a problem when looking for outside funding. According to Benaich, VCs want to make sure that founders are properly incentivized to build companies over the long-term through multiple increasingly large rounds of dilutive financing. Giving away even 10% to 25% of equity to universities from the beginning means they will rapidly be diluted even in the early stages of funding. Founders can quickly find themselves minority shareholders in their own companies.
VCs are also nervous to have universities as a large part of the cap table due to the often slow and bureaucratic nature of these institutions. Dealing with technology transfer offices, which are responsible for the commercialization of intellectual property, can often be cumbersome, Benaich said, and at the end the university still owns the IP.
According to Macfarlane, while a lot of universities have founder-friendly spinout programs, a part of the problem is that each one decides its own policy. Institutions like Cambridge and UCL demand much less equity—a median of 8% and 9% respectively according to the RAE report—while providing the same amount of support as their peers.
“Universities need to see that 5% of a successful spinout is worth more than 30% of one that isn’t,” he said. “They should be fairly compensated but lower equity stakes will motivate founders, which we need.”
A common policy across the country could prove beneficial particularly in regions that the government is looking to “level up,” Macfarlane stated. Both he and Benaich recommend caps on university ownership.
However, limits on equity stakes may not take into account the diversity of spinouts and their needs.
From the universities’ perspective, a larger equity stake reflects the value that they bring to these startups. For complex areas like quantum computing and deep tech, it can take many years for research to translate into a spinout during which time the institution supports it financially, as well as provides equipment and expertise.
In response, some universities have set up multiple programs allowing founders to decide the best level of support and equity for their spinouts.
Thomas Constant founded his sustainable pet feed startup BeoBia while he was a student at Loughborough University. Unlike traditional spinout programs, he had the option to get access to grants, expertise and alumni without giving up any equity.
“Having to give a big equity stake to a university would have been a huge turnoff for me,” Constant said. “It’s like tier one and tier two support and [the latter] gives us the benefits of university backing without them controlling us.”
Imperial College London also has a “Founders Choice” option where founders are able to receive reduced help for a minimal stake or they can opt to have the university help set up and develop the business for a 50/50 split.
For founders like Constant, they don’t necessarily need the same resources and time as it would take to get a deep tech startup off the ground. The university still gets the marketing benefit of having spinouts and founders get to keep the reins.
“It’s all about options,” Macfarlane said. “Founders should be able to choose the right approach for them. Universities put in a lot of work and if you ask founders in my portfolio a lot of them will say that they were really influential. But policies at some universities need to change to drive growth and push forward innovation that we all want.”
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