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NCET2 Panelists Share Advice for Creating University Spinouts in Tightening Economy

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“Bootstrapping is back,” and university entrepreneurs looking to create startup companies in the current uncertain economy should think about further developing their technologies before seeking venture capital funding, a panel of experts said during an online seminar held this week.
 
In addition, universities seeking to launch startups based on discoveries made by entrepreneurial faculty or students should be prepared to be as flexible as possible in negotiations with venture capitalists in the current “buyers market;” and need to provide their prospective spinouts with as much support as possible throughout their early development, the webinar participants said.
 
The webinar, “Startups in Uncertain Times,” was sponsored by the National Council of Entrepreneurial Tech Transfer, and convened a panel of experts from the university tech-transfer, angel investor, venture capitalist, and law communities to share experiences and pointers for creating university-based spinout companies in light of the recent economic downturn.
 
And while the webinar participants were quick to point out that the current financial climate makes it more difficult than usual to launch companies from universities, the news wasn’t all bad, particularly in the life sciences and cleantech sectors.
 
“The US is still the driver of innovation in the world, and one thing I take heart of is that universities, government, and corporate labs are still flooded with government funding to develop great innovations,” Matt McCooe of New York early-stage VC Chart Venture Partners said. “We still have some of the best and brightest researchers in the world trying to create solutions to problems, and the next big set of innovations will come out of the universities.
 
“The great companies and great technologies are being developed inside the university lab, and for the last 20 years or so, have always gotten funded,” McCooe added. “If a great scientist is working on it, that technology will have a lot of legs and it will get funded.”
 
At the same time, McCooe said, the bar has been raised for startup companies seeking VC funding, as many VCs are more carefully considering their strategies. For one, Chart Venture Partners is “taking the barbell approach – either going later stage at lower valuations, or going really early stage. The notion is that in a recession you don’t want to spend a ton of your precious capital right now.”
 
If a university-developed technology has a strong scientific team surrounding it, “this seems like a good time to … further develop your product,” McCooe said, adding that CVP has portfolio companies that are currently “hunkering down for the next 12 months to do just this.”
In terms of specific industry sectors, McCooe said that the cleantech sector “has been incredibly frothy” for deal-making, and “software and biotechnology, which are core areas of focus for universities, have dominated as well in the last quarter.” Further, he said that security and defense technologies are fairly recession-proof markets, “and if the technology has dual use, and can also be applied to commercial markets,” that makes a startup more attractive.
 
This is all great news for universities, McCooe said, adding that “the flight to quality is going to drive people to want to work with universities. It can be a much better foundation for a company than a couple of guys in a garage.”
 
Still, university entrepreneurs seeking to commercialize their inventions through a startup and the university tech-transfer offices that facilitate their ventures must be willing to make some concessions when seeking funding, the panelists said.
 

“The great companies and great technologies are being developed inside the university lab, and for the last 20 years or so, have always gotten funded. If a great scientist is working on it, that technology will have a lot of legs and it will get funded.”

David Lerner, director of new ventures for Columbia University’s Science and Technology Ventures, offered up a few pointers for his tech-transfer colleagues, including: “get your deals closed – don’t dilly-dally; don’t argue over silly, small terms; be able to see the big picture; and be creative with your portfolio companies that need help.”
 
Lerner said that this is especially true when a university takes an equity position in one of its startups, typically in exchange for access to intellectual property ownership – a more frequent occurrence in recent years.
 
“When you hold equity as a university, it perhaps takes things to a different level in that you are a partner and it requires teamwork,” Lerner said. “We’re always looking to help our portfolio companies, even when we’re not having rough times economically. In this climate, most tech-transfer offices are trying to get deals closed, and not arguing over small points.”
 
Lerner said that schools might want to consider initiatives such as internal proof-of-concept or validation funds; actively scouring the entrepreneurial community for individuals willing to take on a startup company based on a university technology; and even bringing in entrepreneurs-in-residence as possible future executives of spinouts.
 
“Also, keep your deals as simple as possible both in structure and in terms,” Lerner said. “Yes it takes courage to start a company during this time, but when things turn for the better, in a year or two you will have a head of steam. We in the university community should be creative in helping startups overcome the issues they are experiencing now. Maybe they need more IP; or maybe they need temporary amendments to a licensing agreement.”
 
Lerner added that universities are “not [startups’] parents; we’re their partners. It’s rough out there and we need to help them. They should always feel they are entering into a helpful and collaborative environment where the university is an ally.”
 
Paul Sciabica, executive director of early-stage investor consortium New York Angels, assured prospective entrepreneurs that despite the economic downturn, “there is money available from investors looking for good management and products in growing markets.”
 
However, “in this day and age, when you come to angel investors, you need to have a product,” Sciabica said. “Have something up and running. Don’t plan to take our money without having to give up any equity at all. You will be in a much stronger position if you have an ongoing concern, you have some revenue, or you’ve taken some of the risk out.”
 
In the biotech or pharmaceutical sectors, this means at the minimum having animal data on a potential product, Columbia’s Lerner said. “This is a minimum for any kind of activity,” he noted. “Stuff prior to that is not really looked at carefully or taken seriously, even from a licensing perspective.”
 
Further, Sciabica said that the days are over where entrepreneurs would seek $500,000 or more to build a startup. “We have a couple of companies in our portfolio that started with $30,000 or so,” he said, and they have built their business through bootstrapping, employing techniques such as outsourcing to other countries, tapping into university networks for support, and “keeping their day jobs” and working on the startup in their off hours.
 
Lerner agreed that it’s a good idea to “bootstrap it as much as possible before you go out for funding. It’s a lot less expensive to do this stuff nowadays.”
 
Sciabica also said that entrepreneurs and universities must be more flexible in terms of pre-funding valuation of their technology or company. “It’s a tough market out there, and the market is going to decide what pre-valuation is. The squeeze is from both sides. You’re going to get squeezed by your investor, and then you’re going to have to go compete in a really crappy market. You’re going to have to take percentages off of your expected revenues.”
 
Added Sciabica: “I sound like the grim reaper, but I’m not. We’re active right now. We’ve got money and we’re putting it to work.”
 
One thing that most webinar participants seemed to agree on is that in general, the biotech and cleantech sectors may be best poised to weather the economic storm in terms of being able to create new startup companies.
 
Shalom Leaf, a New York-based corporate securities and licensing lawyer with his own independent practice, said that in the current market, there is less overall funding to go around and greater selectivity, but investors “may show more preference for deals with longer realization, biotech deals in particular.”
 
Leaf said would-be entrepreneurs should pay close attention to the lessons learned after the IT bubble burst in the 1990s. This translates into a “shifting balance of power to financing sources and away from management, who might be wise to “bargain for as much certainty as they can.” This could mean that investors are likely to provide lower valuations, be less willing to work through diligence issues, desire to decrease founders’ stakes in a company, and push for deferred vesting and compensation to founders.
 
In the end, investors are always keeping an eye on potential exits, and in response to a question from a webinar listener, Leaf said that the life sciences sector may continue to be one of the most attractive sectors in this regard due to increased pressure on large pharma and biotech companies to fill their pipelines.
 
“In the first three quarters [of this year], I believe there is something to that,” Leaf said. “We are seeing more purchases as opposed to IPOs, and the reverse merger market has become much more active in biotech and pharma. The other question that is implicit behind this is whether biotech and pharma are attractive in the current environment. My impression is that they are extremely attractive and will remain so.”

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