Manish Singh and Tina Baumgartner
Biotech companies are often based on great, exciting, innovative ideas. After that exhilarating first step to start a new company it gets a lot more practical quickly: the fledgling startup needs a solid fundament to survive, grow and prosper and for that the founders needs to secure the rights to that innovative idea or cutting edge technology.
In the biotech industry, start-up founders are often academics and (co-) inventors of the technology, in short people who have spent years conceiving and perfecting the technology and are in a unique position to understand its potential and limitations. However, inventor often does not mean owner: academic institutions retain the rights to inventions made in their labs and the founders need to license the technology to be able to use it even though they were the ones who developed the idea
Academic founders are often reluctant to start a company on their own which creates an opportunity for entrepreneurs who don’t own technologies. The tech transfer offices at government research institutes like NIH and NCI, and universities like MIT, Stanford or the UC System are great examples of places that list technologies available for licensing.
Negotiating a licensing agreement can be a daunting task and getting legal help is a good idea. But a lawyer alone is not enough, the key terms of a license go to the core of the business model and a member of the founding team has to be closely involved in the negotiation.
Who Should Negotiate?
The logical first pick of negotiator, the academic inventor, is usually the wrong choice because they are not trained in structuring and negotiating licensing arrangements. The way to go is to select a person with prior licensing experience, e.g. be founding CEO who is also not affiliated with the institution, to lead the negotiation of the often controversial license terms. Although the overarching goal for both parties is the same: commercial success, both parties perceive the negotiation as a zero sum game and licensing professionals have a tendency to try to extract too much out of these licenses. The old saying “better a small piece of a large cake than a large piece of a small cake” holds true, but in the end both parties rather want a big piece of a large cake and negotiate accordingly.
An ideal agreement gives the start-up broad rights and thereby ensures that the terms of the license agreement don’t end up creating a barrier for financing by investors or acquisition or licensing by a pharmaceutical company. On the other hand: broad rights generally command a higher price and therefore good negotiation skills paired with some flexibility are required to obtain the optimal outcome.
The Key Terms – What to Focus On
License agreements can run for many pages all of which are important and need to be read carefully, understood and discussed with a lawyer. But among all the definitions, general provisions and clauses about liability and warranties is a set of key terms that deserves particular attention:
Subject Matter and Field of Use – What Are We Talking About?
Subject Matter defines the intellectual property that is covered by the license and Field of Use defines the applications that IP can be used in. Defining Subject Matter and Field of Use is not as straightforward as one might think. The devil, as always, is in the detail. IP is not just patents but includes copyright, trademarks and know how and the licensee needs to get all the pieces they need to be successful in all applications the new company plans on working on. On the flipside: there is no point in paying for IP that isn’t needed or an application that has nothing to do with the business.
These three steps are important:
- Careful business planning: the founders need clarity and agreement about what the company will actually do, which IP is necessary to be successful and which would be merely nice to have
- Defining Subject Matter and Field of Use early in the negotiation so everybody knows at all times what they are negotiating over
- Spelling it out: the license agreement should have a list of all licensed IP with clear and comprehensive descriptions attached, e.g. as an Exhibit and contain painstaking definitions of the Fields of Use.
Getting this part right goes a long way to avoid future legal trouble.
Scope – What Can the Licensee Do and Not Do?
Scope deals with what the licensee can do – and not do – with the licensed IP. “Do we want to use it for research, modify it, make and sell products, have a third party make and sell products, sublicense it?’ – are typical considerations when defining scope. As with subject matter, the challenge is to get everything needed but not more if that increases the price – as it generally does.
Scope also includes the definition of the geographic region for the license. Worldwide rights always sounds good because it leaves all doors open but the price of a worldwide license can be steep and might not make much sense. If the founders have no plans to sell or manufacture products in a certain region it makes little sense to include that region.
Scope also includes the contentious question of exclusivity: licensees want exclusive rights, licensors hate to grant it. The reason is that both parties try to limit their risk: for the licensor the risk is that the start-up muddles along and doesn’t generate a meaningful stream of income. For the licensee the risk is that a competitor obtains the license and outcompetes them. Both concerns are valid and therefore most negotiations end up somewhere on the continuum between fully exclusive and completely non-exclusive. Exclusivity can, for example, be tied to financial milestones: if the licensee fails to make the minimum payments they lose exclusivity. The opposite is an option on exclusivity that can be executed if the licensee meets defined milestones. Co-exclusive deals allow the licensor to grant a small and defined number of non-exclusive licenses generally to companies that do not directly compete with one another.
The duration (term) of license for a drug candidate or a platform technology should be as long as possible. Ideally, until the patent expires. In the case of biotools licenses often run for shorter periods of time. State-of-the-art technology can change quickly and being tied to one tool or technology can end up being a disadvantage. Some academic centers want to continue to collect royalties even after the patent expires and this could be allowed with significant reduction in the rates.
Financial Terms – Where the Rubber Meets the Road
Negotiating the financial terms requires a balancing act between short-term cash flow and long-term revenue considerations. Typically the licensor will seek an upfront or technology access fee, annual maintenance fees, milestones payments plus royalties. The upfront compensates the licensor for the investment already made in the IP. Maintenance fees help offset ongoing cost associated with managing the patent portfolio and milestones reward the licensor when significant progress is made, e.g. the successful conclusion of a clinical trial. Royalties, generally a percentage of the revenues made from products or services using the IP, are a way of sharing the commercial success with the licensor. In most negotiations, technology access, maintenance and milestone payments move in opposite directions of royalties: if the licensor wants to increasing the upfront payments the licensee will try to reduce the royalties and the other way around. In these negotiations the start-up often finds itself between a rock and a hard place: the upfront drains scarce cash and royalties will reduce earnings in the future. The decision what to prioritize rests with the founders and the answer can be very different for different companies.
A high-level overview of royalty rates for healthcare and pharmaceutical companies is shown here:
Future Developments – Managing Innovation
A fourth important set of terms deals with future improvements and new IP created based on the licensed one. The critical questions are: How do we deal with improvements made by one party alone or by both parties collaboratively? Who owns them? What rights does the other party have? These important questions need to be dealt with while avoiding a common pitfall: anticipating countless “what if” scenarios and trying to address them in the original license. It is often best to clarify basic ownership principles and leave to rest “to be negotiated in good faith”.
Parting as Friends
Securing the foundational intellectual property is critical for every start-up. Investors, partners, collaborators and potential acquirers will do diligence not only on the quality of the technology but also on how well it is secured. The IP portfolio of a biotech company will never be complete, as technology and markets move the company needs to grow and adapt, develop, buy and/or license new technologies to remain competitive. The foundational technology, though, plays a uniquely important role: it gets the company out the gate and into the race.
It is hard to overstate the importance of that first license agreement. The goal of that negotiation is to get the best possible deal for the fledgling startup – but not at the cost of a permanently damaged relationship with the licensor. In the end, licensor and licensee have a common goal and often also collaborative work ahead of them. Starting that road with a committed partner instead of a ticked off adversary is worth a little flexibility.