Reviewing SAIL: University Compensation
Reviewing SAIL: University Compensation
Reviewing how the SAIL license agreement benefits all concerned
Last week we released Simple Agreement for Innovation Licensing (SAIL), a proposed framework for Canadian tech transfer that seeks to simplify the licensing process for post-secondary IP.
Today, and over the next few weeks, we will dig into each section of the agreement in detail, providing a rationale for the choices we made, the intention behind them, and guidance on practical implementation of the agreement.
Today’s article focuses on the parties to the agreement, what each of them gets out of it, and logic that guided the framework suggested by SAIL. You can find a copy of the agreement below for reference. I suggest reading specifically the Core Design Principles section of last week’s article before diving in.
SAIL Roles
SAIL is written as an agreement between three parties: a University, an Investor, and a Licensee. In practice, the agreement will usually actually be a two-party agreement between a startup company and a University, with the University playing the role of the Investor as well.
SAIL also defines a fourth role, Licensor, which can be either (and only) one of the University or the Investor. Use of these three terms delineates responsibilities of each throughout the agreement. Whoever holds title to the IP should be assigned the Licensor role, and whoever holds the convertible debenture issued by the Licensee in consideration of SAIL will be the Investor. In practice, there is nothing wrong with the University filling all three roles.
This separation between the University, Licensor, and Investor roles is a nod to the fact that some Canadian universities use a third party tech transfer organization to manage their IP (notably, Axelys provides tech transfer services for almost all Quebec universities with the exception of Sherbrooke and McGill), while at the same time there is currently an increase in the number of universities with dedicated pre-seed investment funds that may in the future seek to play the role of equity holder, a topic that I will explore in detail in an upcoming article.
Investor Consideration
Convertible Debt
One of the Core Design Principles of SAIL is that it is usually not possible to assign a value to a deep tech startup at the tech transfer stage. The technical risk of deep tech combined with the fact that it is often the case that the full range of applications has yet to be defined makes a valuation exercise impractical. On the other hand, the cost of the intellectual property in question is clear and easily defined: the sum of the research money spent developing it, plus anything paid by the University in securing protection for it.
Cases where value is ambiguous but cost is not are precisely what convertible equity instruments were designed to handle, and so SAIL is built on a foundation of a convertible debenture. By default and as written SAIL works with the widely-used YCombinator SAFE, but other types of agreements can be used provided care is taken to ensure that definitions are in accord.
The dollar value of the convertible debt should capture any contribution made by the University, Licensor, and Investor for which it has not already been compensated by other means. The research dollars spent to develop the IP are already covered, by taxpayer- or industry-funded research grants in most cases. However, that which has been spent in securing the IP has not, and it is common practice for tech transfer offices (TTOs) to seek reimbursement for these costs as a condition of licensing. The amount of the SAFE contemplated by SAIL then is the sum of that which has been spent by the university to secure protection, including direct costs and person-hours. SAIL allows addition of an optional initial license fee, which should be $0 in most cases, but can be adjusted for exceptional circumstances. Practical guidance on implementation laid out in Schedule B.
As a point of comparison, Waterloo’s tech transfer office takes 5% equity in exchange for their involvement in protecting IP when their researchers request their involvement. This is predicated on the assumption that protecting the IP will cost about $50,000 and a reasonable pre-seed valuation for a deep tech company is $1M in the absence of any more information. Depending on the scope of protection sought, the amount of convertible debt issues via SAIL could range from $30,000-$50,000 is the guidance in Schedule B is followed, which would convert to approximately 3-5% equity when considering recent deep tech pre-seed round valuations in Canada.
In other words: the outcome of using SAIL is not so different from what the leading deep tech commercialization university in Canada is already doing, and it provides additional flexibility to allow more accurate value capture exercise on conversion of the SAFE.
This approach also ensures that the university (and thereby the taxpayers that funded the research) also benefit not just from cost recovery on the IP, but from its long-term value, if such a thing materializes, in proportion to the cost of their contribution at the interface between research and development. Inventors not involved in the commercialization effort would have proceeds of that equity (if any) shared with them and the university according to institutional policy.
No Royalties, Milestone Payments, or Up Front Fees
SAIL is royalty free and does not require cash payments on completion of milestones.
Deep tech startups typically do not have much in the way of resources. It is a Core Design Principle of SAIL that every dollar accessible should go to development of the startup and to building value in the technology portfolio, focused entirely on long-term impact.
While SAIL does allow for a portion of the costs of the University to be recovered up front in cases of policy-dictated or practical necessity, we suggest that this be minimized to the extent possible: as an equity holder, the University is literally invested in the success of the startup, and taking fees reduces the chance of success. A dollar spent on a fee is a dollar not spent building value in the equity.
Similarly, milestone payments based on detailed technology roadmaps are to be avoided, for two reasons. The first is the same as the issue with royalties: paying fees instead of building value devalues equity, and so should not appear alongside it in a single agreement. The second is more subtle. Deep tech is often multi purpose and the chance that an early technology road map plays out as planned is effectively nil, while at the same time, deep tech startups almost never have revenues in the early stages of development. If a company is forced to hit certain milestones, it can result either in that company not pivoting when they should and getting off track due to misguided contractual obligations, or (if the milestones are not compulsory) it can incentivize a pivot away from the right course of action, or a delay in order to avoid or defer those fees. In either case, technology-based milestones distort incentives in a way that devalues equity.
While most universities are willing to renegotiate milestones if they no longer make sense, the concept of renegotiation as a built-in contractual mechanism is deeply unattractive for investors, who generally prefer to have everything clearly defined up front. SAIL seeks to establish an agreement up front that is sufficiently general and flexible as to not require such renegotiations.
Variable Convertible Debt
Where SAIL’s use of a SAFE differs from most is that it has an optional variable component to the convertible debt issued, described in Schedule B as “Post-Effective Date Costs.” In the event that the University provides ongoing support to the company (for example, lab space rental, continued IP management services, etc.) and all parties agree to defer payment, that deferred payment can be added to the amount of the SAFE on an ongoing basis. This gives universities a way to increase their investment in a technology without needing to make a formal investment while giving startups a means to offset or defer costs in the pre-revenue, pre-seed stages in which they require the most support.
Wrapping Up
Next week, we will get into the details of how SAIL satisfies Core Design Principle 1: that SAIL should never block innovation. We will cover issues of exclusivity, IP assignment, and clawback of the IP in case of failure to delivery on the part of the Licensee.
If you are interested in getting involved in ongoing development of the SAIL framework, reach out directly to the co-authors at the coordinates below:
You can find other entries in the SAIL series in the following articles.
