The IP licence: A key building block for life science spin-outs

There are currently over 1,100 active spin-out companies from UK academic institutions according to a recent joint Beauhurst and Royal Academy of Engineering publication (2023).

The publication makes interesting reading. As you would expect perhaps, the most active sector for spin-outs is life sciences - including businesses involved in drug discovery, clinical diagnostics, medical devices and research tools. The report mentions that increasing amounts of funding are being invested in the sector generally, with five times as much being invested in spin-outs companies in the UK compared to 10 years ago. According to this publication, £2.1 billion was invested in 2022. This is a considerable sum by anyone’s reckoning.

One of the key building bricks for university spin-outs, more often than not, is an IP licence from the host institution. The terms of this licence are clearly important for all spin-outs but can be especially material for life science companies where underlying IP assets are often of key and long term importance to the business. This licence may be part of a wider suite of arrangements which may include the institution taking equity in the spin-out. However, the spin-out is generally expected to operate as standalone business as it grows, and ultimate success will depend on a number of factors including its financial viability and the market for the spin-out’s products or services.

It is vital that the terms underlying IP arrangements with the host institution aid, rather hold back, the spin-out as it moves forward and are sufficiently well drafted to anticipate the company’s growth and future needs. Trust between the parties with an underlying approach to the commercial and legal terms being one of partnership and mutual interest in the spin-out’s success can make a huge difference to negotiating and agreeing the terms of a well drafted licence which will stand the test of time.

Circumstances may arise however where an IP licence between an academic institution and the spin-out involve protracted and difficult negotiations - or the licence put forward by the institution may be entered into without due consideration by the spin-out. Either way, this can be a result of the many demands on the time and energy of the spin-out’s management team when there is so much to think about - and where the main focus is often on raising sufficient capital to get the business underway. Often in both such instances it can transpire down the line that this key agreement does not sufficiently anticipate the company’s needs and it has to be renegotiated which with goodwill on both sided may be easily achieved -but at times this process may not go smoothly and can become contentious. Whilst nobody has a crystal ball which can anticipate all of the future IP needs of the spin-out, it is certainly the case that with some thought and planning more can often be done to ‘future proof’ this initial IP licence.

Here are some thoughts on important issues for spin-outs to consider when reviewing a draft IP licence put forward by an academic institution:

• Make sure the licence is bespoke for the business of the spin-out – ‘standard’ licences may be suggested but rarely work - every business is different and the licence needs to be drafted in line with the spin-out’s business plan and intended use of IP assets in its products and/or services.
• Make sure that all of the institution’s existing IP required by the business is included in the licence - list all patents/applications, ensure that know how is properly defined, that it does have substance and that it is clear how and when know how will be communicated - ideally in writing. Also, with the coming into effect of Unitary Patents and the Unified Patent Court be sure to make sure that if European patents / applications are to be included that the licence covers these matters.
• If University ‘improvements’ are to be included, check that the wording reflects what is expected and which improvements will be included - this detail can be ‘hidden’ in the Definitions section and can be often overlooked. As the spin-out moves forward, access to such improvements may be very important.
• Financial terms are clearly very important and great care needs to be taken with drafting these provisions - for example in relation to how royalty payments should be calculated. There have been three recent cases in the English Courts dealing with disputes over royalty provisions in licences and their interpretation. An important take-away from each of these cases is that great attention needs to be paid in defining the payments which will be used as a basis for calculating royalties due and payable to the licensor.

An illustration of where difficulties may arise is where royalties are to be payable on US sales. In the US there are complex rebate and distribution arrangements built into the system which may reduce sales payments made to the licensee -and this situation may result in disputes as to how royalties are calculated . In such circumstances is it the ‘sales price’ of the product as put onto the market in the US by the licensee which will be used as the basis for calculating royalties or, alternatively, is it the sum actually received by the licensee from US sales (after taking these complex rebate and distribution payments into account) which will be used as a basis for calculating royalties due to the licensor? The drafting of the licence needs to be very clear on this point.

Also, be aware of the fact that in the US there is a doctrine of ‘patent misuse’. This may catch royalty payments agreed to be made in terms of the licence. Where the licensed patent has been revoked or has expired in the US, a ‘step down’ in royalty payments may be required to comply with US laws. If no such step down has been provided for then payment of royalties may not be enforceable. US legal advice should therefore be taken as to how structure royalty payments in order to ensure that they comply with this doctrine.

• Be sure to check generally the definition of ‘net sales’. This definition can also make a big difference to the sums actually paid under the licence. From the spin-out’s perspective, make sure that fair and reasonable deductions can be made prior to calculating payments such as transport and delivery costs, insurance and discounts in the ordinary course of trade and tax. Also, if possible, ensure that payments are only due on sums actually received by the licensee. In addition, make sure that the spin-out is able to make a reasonable profit on sales once royalties have paid - strange as it may seem this may not always be the case! If ‘combination products ’ are envisaged (for example where there are two or more regulated components in a medicinal product, or where two or more products such as a drug and a device are being combined together as a unit for sale) make sure its clear how royalties are to be calculated. An allowance should be made for any payments to be made to third parties for components of the product which are not part of the IP licenced from the academic institution.
• Make sure that any performance targets imposed on the spin-out are reasonable, especially since in the early days the business may not go to plan and there can be delays or changes of direction which can’t be foreseen when the licence is signed. This is important as often the ongoing right to an ‘exclusive’ licence can depend on these targets being reached in defined timescales, so take care in drafting and make sure if possible that there is some leeway, especially if circumstances outside the control of the licensee delay performance e.g., any regulatory hurdles. Also, milestone payments require careful thought as to the triggers. Often in spite of considerable efforts all may not go to plan or plans may change along the way for good technical or scientific reasons.
• If sub-licensing a key part of the business, make sure that the right to sub-licence is included in the agreement - this right will not be implied by law. Make sure that any procedure for approval of sub-licensees is not unduly onerous and time consuming - also ensure that thought is given to the percentage of sub-licensing income payable to the institution and make sure it is reasonable.
• Regarding patent costs, it is often the case that the spin-out has to reimburse the university for historic costs - make sure the numbers are fixed and transparent at the outset - and that if the spin-out is responsible for the institution’s ongoing  patent costs, that these costs are discussed and agreed upfront so that there are no surprises - the sums involved can be considerable.
• Whilst it’s understandable for the institution to require ongoing rights to carry out research using the licensed IP, make sure that the extent of such rights is understood and clearly limited to ‘non-commercial’ research. Ideally, the scope of any right should be expressly limited to teaching and research only. Review carefully the wording proposed by the institution to make sure it won’t have an undue negative impact on the spin-out e.g., make sure there is no right for the institution to exploit the IP commercially.
• Whilst providing for publication rights for the institution are to be expected, make sure that the spin-out has the right (and sufficient time) to review any proposed draft university publication(s) in advance, that its comments will be taken into account and that provision for new patent application(s) will be made prior to any publication. Otherwise, this could prejudice the patentability of any inventions disclosed in the publication. Steps should also be taken to ensure that none of the spin-out’s own confidential information will be included in the publication(s) and that if any student thesis is on the cards, it will not be generally accessible in the university library.

There are many other points to note on licensing, but hopefully this article provides some useful guidance. An IP licence should be a win-win for both parties and represent the start of a long term, positive and supportive relationship. Maintaining good communication between the parties is very helpful after the licence is signed and can really assist in addressing any unexpected issues which come to light. At the end of the day, it’s in everyone’s interests to work collaboratively to make sure the spin-out has the maximum chance of building a successful business!

Our Healthcare & Life Sciences team has experience in all aspects of spin-out licences and would be happy to help you ensure any terms you agree to are right for your business. Please get in touch if you’d like to know more.