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Carnegie Mellon
Center for Technology Transfer and Enterprise Creation 4615 Forbes Avenue Pittsburgh, PA 15213
Guidelines –
Formation of Carnegie Mellon University (“CMU”) Spin-Off Companies
I. Objectives
Objectives for CMU’s Technology Transfer and Enterprise Creation Program
- To facilitate the successful dissemination of technology created at CMU for the benefit of society, the region, and CMU and its creators.
- To make CMU an attractive environment for highly talented, entrepreneurial faculty and students.
- To assist in regional economic development.
- To generate revenues from CMU technology.
- To generate future CMU revenues in the form of gifts and research partnerships from entrepreneurs and companies who have benefited from technology created at CMU. Objectives for these Guidelines and their Use
- To clarify and simplify the process by which inventive and enterprising CMU people may start new companies based on technology they create at CMU.
- To establish clear, fair and consistent practices and standards for the formation of CMU spin-off Companies.
- To make these practices and standards widely known and understood throughout the CMU community.
II. Basics of CMU Technology Transfer - Licensing and Spin-off Formations
a. The Initial Disclosure The first step in working out the arrangements for licensing and/or spin-offs is for the Creators of a technology to complete a CMU Invention Disclosure form (see CTTEC website Resources page) and to discuss that disclosure with the Center for Technology Transfer and Enterprise Creation. b. The Business Strategy All spin-off companies should have a defined, plausible business strategy and a plan for its execution as described in their business plan. A business plan is typically most effective if (i) with the help of experienced entrepreneurs and/or qualified professionals, it is created by the Founders themselves and (ii) it defines the objectives and the critical steps required for taking a technology to its commercial implementation, normally including the following elements: Spin-off company’s technology and its status;
Expected spin-off company products and/or services; Targeted market(s), customers, distribution channels; Size of targeted market(s); Competition, both technical and commercial; Marketing and sales strategy of the spin-off company; Unique advantages of the spin-off company, compared to competition; Economics of the business, starting with expected gross margins, i.e. the difference between selling price and product (or service) cost; Organization and key people involved, including CEO, key officers, board of directors, advisory board; Key staff and consultants; other key employees; Operating plans, financial assumptions; Financial forecasts; Financing objectives and/or plans, including valuations, financing sources and expected spin-off company ownership and governance; and Current status of the spin-off company and expected schedule of actions, events, and accomplishments. An effective and plausible business plan is best be created by the people who will be responsible for accomplishing the plan, namely the prospective CEO and the other key leaders of the business. It should be developed as much for ‘internal’ as for ‘external’ purposes and should essentially become a ‘set of instructions which the spin-off company writes for itself’. Assistance by competent consultants or advisors can often be helpful but should not take the place of the personal involvement and commitment of the prospective key leaders of the spin- off company. The existence of a plausible business strategy is one of the requirements of the Center for Technology Transfer and Enterprise Creation for engaging in serious licensing and spin-off company-formation discussions with potential creator-founders. A substantial number of organizations are available in the Pittsburgh region, at CMU, as well as resources and capabilities within CTTEC itself, which can assist entrepreneurs in the planning and execution of new company spin-offs. Links to the websites of such resources are provided on the Resources page of CTTEC’s website. CMU encourages new entrepreneurs to make full use of such resources.
c. License Terms
Transfer of CMU technology will always involve a license from CMU to a licensee whether it is an existing company or a spin-off. Such a license might be exclusive – typically for one or more specific “fields of use” and/or for a specific period of time - if the licensee can meet certain development and product milestones; or non-exclusive with somewhat fewer and less stringent milestones.
CMU’s equity ownership in the spin-off at the closing of (i) the first major financing (aggregate investment into the company of $2M) or (ii) of a change of control event (such as a purchase by another entity), whichever comes first, in a Standard Deal shall amount to --
- 5.0% if the license is non-exclusive,
- 6.0% if the license is exclusive. (Note: The 1% difference represents the premium for exclusivity). The calculation of such ownership percentages shall include all classes of shares, options, and warrants outstanding at the time of the calculation. Such ownership percentages are to be accomplished by issuance to CMU, on the effective date of the license, of (i) shares in the spin-off and (ii) a warrant for the acquisition of additional shares by CMU designed to accomplish CMU’s equity ownership as defined above. The securities to be owned by CMU shall have terms, conditions, financial and other provisions that, in addition to rights described below in “Rights with Regard to Future Equity Transactions” are no less favorable than those of the securities to be owned by the creator-founders and other shareholders. Similarly, CMU’s rights under the company’s shareholders’ agreement shall, in addition to rights described below in “Rights with Regard to Future Equity Transactions” be no less favorable than those of the creator-founders and other shareholders.
c. CMU Royalties (% of revenues from sales of products based upon technology licensed)
In recognition of the typical shortage of cash during the initial phases of a spin-off, the license agreement will provide–
- that no royalties shall be due or payable to CMU (and/or any of the creator-founders) for a period of three (3) years following the effective date of the license or until the closing of a change of control event , whichever may occur sooner;
- after such time, royalties to CMU for the remaining term of the license shall be payable quarterly in the amount of –
- 1.0% if the license is non-exclusive,
- 2.0% if the license is exclusive. Such royalties will not be shared by CMU with creator-founders. If one or more of the creators do not wish to become creator-founders and to negotiate their own financial arrangements with the spin-off, the arrangements defined under “Special Situations” will apply.
d. Milestones
An exclusive license will involve milestones that define reasonable progress of the spin-off in order to avoid the possibility of a “dead” or weakly performing license that would block the licensing of a CMU technology to others if an initial, exclusive licensee has not been able to accomplish reasonable commercialization of the technology. If such milestones are not met, an exclusive license may, at CMU’s discretion, be made non-exclusive or be terminated in accordance with the provisions of the license agreement.
Reasonable milestones are to be proposed by the founders of a spin-off and must cover at least the following key events and their respective expected completion dates:
- Completion of an acceptable business plan
- Initial product development and market testing
- Initial rounds for financing
- Commercial product introduction (“first commercial sales”)
- Minimum revenue targets during the first five years A nonexclusive license will also involve milestones but less stringent ones that, nevertheless, will be designed to avoid the possibility of a “dead license”. Non-compliance with such milestones will be a cause for terminating the license.
e. Rights with Regard to Future Equity Transactions
As part of any deal under these Guidelines and as is not uncommon for initial shareholders of spin-offs, CMU shall also receive the following rights with regard to future equity transactions, with such rights to be in effect until a change of control event:
- “Preemptive rights” which are the rights of current shareholders to maintain their fractional ownership of a company by buying a proportional number of shares of any future issue of common stock;
- “Piggyback Registration Rights” which are the rights of shareholders to register and sell his/her unregistered stock in the event that the company conducts an offering.
- “Co-Sale Rights” which are the rights of shareholders to participate in any proposed sale of the company’s stock to third parties. f. Board of Directors If and for as long as CMU has equity ownership in the spin-off or its successor company of 10% or more, CMU will have the automatic right to appoint a member of the board of directors of the spin-off. Such board representation may otherwise be requested by the spin- off and will in that case be at CMU’s discretion.
V. Expanded Deal
The Standard Deal will not include any services by CMU other than normal services provided by CTTEC, with expenses thereby incurred to be charged to the relevant CTTEC docket. Such normal services may include (1) the completion of normal License and Split agreements, (2) providing Enterprise Creation services which may be helpful to the spin-off, and/or (3) continued prosecution of any patents associated with technologies licensed to the spin-off (with the expenses to be reimbursed by the spin-off).
The question may arise if the equity percentage (and the royalty rate) for CMU should differ from the norm (i) if the CMU license to the spin-off covers more than one technology or (ii) if CMU concludes more than one license with a spin-off. Assuming that the combining of more than one technology into one spin-off company makes good business sense, the answer is that the percentages should remain the same. This is based on the following logic: Assuming that CMU is entitled to x of any “package”, a larger package should produce greater dollar returns than a smaller one. For example, 5% of two “single-sized packages” should produce the same dollar amount as 5% of one” double-size package” – assuming that the business merits, expenses, etc. of the two alternatives are comparable. The commercialization analysis and business planning for a spin-off program involving more than one technology should, however, concentrate on developing the optimum business strategy and business economics and the relative business merits of creating one or more than one spin-off company. For example, if two technologies a related and together can create a more powerful product and marketing offering, the combining of the two technologies into one spin-off company may have obvious benefits – not only in marketing but also by saving the spin-off effort, time and expenses, having to carry overhead expenses for only one versus two operations, having to recruit only one executive team, etc. On the other hand, if the two technologies are not closely related and/or if each addresses a different market or type of customer, it may improve the odds of their combined business success if separate spin-offs are created for each of these technologies, each with a dedicated management team with a single mission and with a sales and marketing program aimed at the specific customers of each technology.
b. Not all Creators are Members of CMU or Wish to Participate in the Financial Structure of the Spin-off
Under any Deal covered by these Guidelines the creators who wish to participate in a Standard Deal, i.e. the creator-founders must negotiate their own financial arrangements with the spin-off company after waiving their normal gain sharing provisions under the IP Policy. There may be cases, however, where some of the creators may not wish to negotiate their own financial arrangements with the spin-off and instead wish to rely on the provisions of IP Policy. Since the IP Policy provides for a 50/50 Split of net proceeds between CMU and the creators, such a case will require that the spin-off assign additional equity percentages to the creator(s) who do not wish to participate directly in the spin-off. The amount of royalties payable by the spin-off will also need to be adjusted. The logic for calculating appropriate financial participation by such non-founder creators is as follows:
- Since CMU’s equity participation in the deals under these Guidelines does not include a split for creators, the equity participation of CMU + creators “under the IP Policy” would be twice the percentage defined in these Guidelines; for example, for a nonexclusive license the combined equity participation per IP Policy would be 5% times 2 = 10%.
- The additional equity percentage to be assigned by the spin-off to non-founder creators will be proportionate to the split percentages of the non-founder creators.
- The amount of royalties payable by the spin-off will be similarly adjusted. Example Assumptions: Standard Deal, nonexclusive license, CMU equity participation = 5%, royalties (after 3 years or after change of control event.) = 1% creator-foundersand their splits: Creator 1 40.0% Creator 2 25.0% Total 65.0% non-founder creators and their splits: Creator 3 20.0% Creator 4 10.0% Creator 5 5.0% Total 35.0% Equity Participation: Additional equity participation to be assigned to CMU to account for the non-founder creators: 5% times 35% = 1.75% Total equity to be issued by the spin-off to CMU (including equity to account for the non- founder creators): 5% + 1.75% = 6.75%. Equity split to be attributed by CMU to individual non-founder creators: Creator 3: 5% times 20% = 1%; etc. Royalty Participation: Additional royalties (in addition to the standard 1%) to be payable to CMU for distribution to non-founder creators: Total: 1% times 35% = .35%; Creator 3: 1% times 20% = .2%; etc. Total royalties payable to CMU (including royalties attributable to non-founder creators = 1% + .35% = 1.35%
c. Sharing of Proceeds from Royalties for all Creator-Founders
VIII. Implementation of these Guidelines
These Guidelines provide only the general principles of the provisions and contractual requirements which will need to be established and negotiated in detail in each specific case. These Guidelines may be changed in the future. They are not a contract nor an offer to enter an agreement on these or other terms. Whether CMU will enter any agreement or license will depend upon the licensee, the technology, and other aspects of the possible arrangements. Each technology and each transaction must be independently analyzed. The University may determine that other terms are appropriate for a particular transaction. If you have questions, please contact the CMU Center for Technology Transfer and Enterprise Creation.
