HoT investment into spin-out playbook

This document is the legal contract that grants the Company rights to use, develop and commercialise intellectual property originating from the University and this has its own separate Licence HOTs document.

This document is a key constitutional document (and subject to public disclosure) that sets out the rules for how the Company is run, governed and owned. The Articles form a contract between the Company and its shareholders, and among the shareholders themselves and is a public document. The Articles are distinct from the Shareholders’ Agreement and the focus of the Articles is to provide a legal framework for the Company’s operation.

This document is a legal contract between the Company and the investors under which the investors agree to subscribe for (i.e. purchase) new shares in the Company, typically as part of a funding round.

This document is a private contract between a Company and its shareholders that governs the rights and obligations of the parties and how the Company is managed. The shareholders’ agreement is distinct from the Articles and the focus of the shareholders’ agreement is to set out the commercial relationship and protections that are too detailed or sensitive for public disclosure; and

This document outlines the Company’s goals and strategy for achieving them. It serves as a roadmap for the business and is used to attract investors and will form a key part of the pitch documentation to investors.

The University has a very significant interest in all aspects of the spin-out deal, since it is a founding institution, committing key resources, and licensing the core intellectual property. The Company may well initially be working within University premises and/or laboratories, and University staff (current or former) critical to the success of the spin-out may be involved in working in, or with, the company. The University is a significant shareholder due to its foundational role in supporting the research and innovation activities leading to spin out creation and, as such, has important shareholder rights and obligations, especially in the initial phase of Company development.

Academic Founders are even more critical for Company formation and successful spin-out launch and are involved in all elements of the spin-out, hence the deal and the HoT. Leading up to spin-out incorporation, they represent the future Company ‘concept’ and act on its behalf. Founders sit at the nexus of convincing the investor(s) to commit necessary funding to launch the spin-out and to take the licensed IP forward into a successful growing venture. Founders identify all necessary IP, people, resources and commitments where provisions will be required between University/Company. Academic Founders will need to complete their Conflicts of Interest Management Plan at the appropriate stage and it is recommended they seek independent legal advice.

Investors want to see the Company established and be able to meet commitments and attain milestones. To achieve this, they will require certain conditions in key parts of the overall spin-out deal package. While investors are not legal parties to all agreements e.g. the IP licence agreement, key requirements will be needed for successful commercialisation and venture stage building, so the HoT is an incredibly useful consolidating document that draws these essential features together.

A research team member who cannot, or does not wish to, have a role in the Company may still be rewarded through the issue of shares on Company launch. They will have a minor involvement in some arrangements, such as confirmatory assignments (usually called a Researcher IP Agreement). These confirmatory assignments underpin the assurances the University can give around the IP and are used to inform these individuals about confidentiality obligations, and what the licensed IP can, or cannot, be utilised for. Generally, the advice is that Non-Founding Academic IP Originator(s) should not be (a) party/ parties in the Heads of Terms.

The legal parties to the licence agreement will be the University (Licensor) and the Company ((spin-out) – or Licensee).

The key founding team have an important role in negotiation, but a conflict situation must be avoided. Therefore, the TTO staff must represent the University while Founders must act on behalf of the Company and must manage that conflict situation. The inclusion of any future management team representatives (e.g. externally recruited CEO) can play a role in such circumstances. Where a conflict may exist through the role of a TTO staff member acting as a Director in the Company (e.g. Non-Executive Director position), additional provisions to avoid a conflict of interest will be required by the TTO.

What IP the University includes in the IP Licence, including the University Improvements pipeline, is likely to impact the relevant research group. Therefore, TTO consultation with Founders’ department(s) is likely to be needed during HoT negotiations, to ensure the granting of IP rights is balanced and fair to all individuals.

Investors provide an input to the IP licensing requirements as they will have a view on the Company’s needs going forward throughout all potential venture stages.

Shareholding: The fundamental consideration for the investor is the shareholding they gain as a result of making their investment into the Company. The ‘Capitalisation’ of the investment is described in the form of a share capital table (or commonly referred to as a “cap table”), and it is customary to outline the cap table position before and after the investment is made – for total clarity between the parties. The Company may wish to incorporate issuing a large number of shares, which can be more easily subdivided between the parties listed on the cap table in proportion to their equity stake. The Spin-Out Checklist document includes a recommendation on the process to follow for this stage. The cap table details in the HOTs Appendix the relevant groups’ shareholding levels at relevant stages of the spin-out process.

An important consideration for all shareholders is around the design of the Share Incentive Plan, covering an option pool to be created. A core principle is that such incentives are for the benefit of the overall Company and hence all shareholders should be diluted to the same extent by these plans. It is customary to include at this point (and display in the cap table) the creation of a share incentive plan (commonly referred to as an “options pool”). The options pool is used to incentivise employees and Founders at various stages of the Company’s lifecycle, by granting options (rights to future shares), which may increase in value as the Company grows and raises investment. The quantum of the options pool can be variable and is determined based on the specific Company needs; and generally guidance is that an option pool of 10% is appropriate and may be taken to a greater level with lead investor approval.

The Company’s business plan may already state who is eligible for share options, as they are a critical tool to attract talent to the Company to bolster a salary by reducing the ‘hard cash’ cost of employees at the early stages. Incoming commercial management and other key talent hires should be the focus for share options, as part of their role in the spin-out and for hitting pre-agreed milestones. It is customary for these shares to ‘vest’ over a period of time, which provides the appropriate incentive for key personnel to not leave the spin-out too early.

Any investor receives shares in exchange for their investment in proportion of quantum invested, relative to an agreed share price, hence the of the company is critical to securing investment at a ‘fair’ price per share. <<A HOTs document simply expresses the subscription price to be paid and we have not explained pricing level methodology in these HOTs>>. An investor will typically scrutinise the Company’s business plan, in order to assess what the spin-out plans to use the investment proceeds for. This is a critical element of the Company’s business plan, and the Founders must raise enough funds to undertake key activities that subsequently increase the valuation of the Company in excess of the post-money valuation.

Setting a share price as part of the investment negotiations can be a contentious point between the parties (Academic Founders, Investor and to a lesser extent the University), as they are trying to maximise their own value in the spin-out. This share price (and therefore whole Company valuation) sets a precedent and will have huge impact on future investment rounds. It is wise to use comparator data to agree a share price and Company valuation ahead of an investment negotiation.

Should the parties require any prerequisite conditions or ancillary agreements as part of the investment, the parties will need to mutually agree and expressly included these in the HOTs. (Further details are given below in section 3.5.)

Should the investors require certain warranties (factual statements to be made by the Founders or the spin-out), these statements must not be taken lightly, as if untrue then damages (often capped) are payable by the breaching party. The Founders and the Company will be able to qualify any warranty statements and further to that, should decide what to include in formal disclosure letters as necessary. Warranties provide investors with comfort about the state of the Company, the validity of the team and the commercial proposition, and also act as mechanism to incentivise those with the detailed, background knowledge (which is normally the Founders) to disclose material matters to investors.

If your investors require their investment to be made under the SEIS / EIS tax relief scheme, then they are likely to insist on Advance Assurance from HMRC. There are certain eligibility criteria, so the Company should ensure it is in scope and seek professional advice as appropriate. The investor may also require an Advance Assurance from HMRC that the investment will be (S)EIS qualifying before completing the investment. The timing for this will need to be factored into the completion timetable.

For University spin-outs, just as with many early-stage start-up companies, several rounds of investments will be likely and suitable mechanisms need to be thought through for dealing with different entities being involved at the different stages. Normally, any new shares in private companies would be expected to be offered to all Ordinary shareholders pro rata. Pre-emption rights, also known as rights of first refusal, give existing shareholders the opportunity to purchase any newly issued shares pro rata. Universities usually do not invest in their own spin-outs at all and Founders are in a similar position, so we generally need specific waivers or carve outs around how to deal with the pre-emption rights of shareholders. Institutional shareholders (VCs) are usually the shareholders who wish to retain the right to avoid dilution of their shareholding.

Under the section on Permitted Transfers investors will normally seek rights to transfer shares and rights between their fund structures, including nominee accounts, and other shareholders (e.g. Academic Founders), similarly, they could transfer to family members and, in the case of Universities, they are likely to want to be able to transfer to an appropriate commercial subsidiary for shareholding purposes.

The ‘Rights of Shares’ section of the HoTs are clearly important for all parties, and do need to be understood by the Founders, as certain actions by the Founders could create costly mistakes. Probably the most important sections relate to Bad and Good Leaver provisions, as leaving will affect share ownership and any value contained.

For the University, as new classes of shares are created, the University needs to be aware of the preferences that are also created. The University share will always be diluted, but the University needs to be aware of the consequences, bearing in mind that it cannot follow-on with its own money, (if that is the case) in future rounds.

It will be important for the University and the Investor to have a right to appoint a director or at least an observer to represent their interests, for as long as their shareholding remains above a certain threshold (e.g. 5-10%). The HOTs are likely to identify who will be directors at early stages and how many directors are required for a meeting of the Board to be quorate.

The shareholders agreement will include a section about decision-making in the Company. The material decisions will require Board approval. Investor will want to ensure that they have some say in the major decisions affecting the Company’s business and the value of their investment. The University, for example, may want to have a say in the Company changing in a material way the nature of its business. The HOTs will include the full list of matters requiring the special consent of the investors and/or the University. This list is an important insight for Founders to realise how Company management to needs to operate in the future.

It is standard practice to include provisions that entitle each shareholder to receive management information, such as management accounts, the business plan, annual accounts. The company should be sharing these documents with investor and the University.

You will also come across non-compete clauses in the Shareholders’ Agreement that will apply to academic shareholders. The University may well wish to appropriately resist such provisions to maintain academic research freedom, but this is a balance, of course, to be sensibly managed as both the individual concerned and employing institution are receiving potential commercial gain. The Universities are large organisations where research conducted in one area could potentially compete with the Company. The University must preserve its freedom to pursue such research activities. Key factors to be considered are:

1. it can only cover the specific individual and not impact on other staff who are not involved in the spin-out,
2. general versus specific restriction(s), where too broad a restriction/ exclusion would be concerning from an anti-competitive perspective, but (say) identifying specific direct companies may be more appropriate and
3. the duration of any restriction.

While personal non-compete obligations for Academic Founders are ultimately their individual decision, with a recommendation they should receive independent legal advice, any such obligations should not restrict the University’s ongoing or future research activities involving those academics, particularly if they continue to be employed by or engaged with the University. Here TTO staff need to ensure that departmental management are well briefed on any research restrictions.

Outlining the terms and conditions for accessing a specific facility, whether it is a premises, laboratory, or other designated area. It is a contract between the facility owner (or a tenant operating the facility) and the access beneficiary, specifying the duration, type of access, services provided, charges, and other essential elements. These arrangements are commonly used as it enables the Company to access world-leading labs and equipment without having to make its own upfront investment, on the other hand, the University can receive a small level of external income to compensate for ‘sweating’ its assets.

Formalise collaborations between Universities and external organisations for research purposes. They outline the rights, obligations, and responsibilities of all parties involved, including funding, intellectual property ownership, and data management. These contracts can be standard agreements, collaborator agreements, or bespoke agreements tailored to specific projects. Any Academic Founders involved in work at the interface between the two organisations will need to comply with their Conflicts of Interests Management Plan when planning for, negotiating and working under these contracts.

Formally define the terms of a consultant's engagement, providing a framework to support the broader terms of a deal. They outline the scope of work, payment terms, intellectual property ownership, and confidentiality obligations, ensuring clarity and protecting both parties involved.

Outlines the terms of a temporary transfer of an employee from one organisation to another, usually for a specific project or period. It clarifies the secondee's employment status, including aspects like salary, benefits, and working conditions during the secondment and ensures a smooth and efficient transition for the employee, as it outlines the roles, responsibilities, and performance management process at the host organisation.

The NSIA mandates that certain acquisitions or investments (such as in defence, cybersecurity, and critical infrastructure), be notified to the government for review. If an acquisition falls under this mandatory notification requirement, clearance must be obtained before the transaction can be completed. Once a notification is submitted, the government has 30 working days to review the acquisition and either clear it, call it in for a national security assessment, or decline to act.

HoTs are not typically used to demonstrate tax clearance (a separate process with its own documentation requirements). However, HoTs can be used as supporting documentation in some cases, e.g. for regulatory filings or to potential funders. Whilst tax clearance is a separate process, the general idea is to provide evidence that any outstanding tax liabilities have been addressed. Documents can include:

• Tax Returns: Copies of filed tax returns, including income tax, VAT, and other relevant taxes.
• Tax Clearance Certificate: A formal certificate issued by the tax authority confirming that all tax obligations have been met.
• Payment Proof: Evidence of payments made to the tax authority, such as bank statements or receipts.
• Other Relevant Documentation: such as proof of registration, tax identification documents, or information about tax-related liabilities.

This often involves scrutiny of employment agreements, loan agreements, shareholder resolutions, and other related documents that may impact the deal. These documents help investors gain a more comprehensive understanding of the Company's operations, obligations and legal standing.

Primarily include resolutions approving the transaction, compliance certificates, and potentially agreements related to shareholder rights, like investor rights agreements. These documents are crucial for formalising the deal and ensuring compliance with corporate governance requirements.

Include supplementary documents that provide additional context, clarify details, or support the main agreement. These can range from board minutes and shareholder resolutions to more specific documents like loan agreements or retention agreements, depending on the transaction's nature.

In summary form, there are two main themes covering the spin-out suite of legal agreements. The first is for the corporate documentation (Shareholders’ Agreement, Subscription Agreement and Articles of Association). These will principally cover how the Company operates and is governed, particularly decision making and the specification of rights in shares in light of the aims of the investment transaction, planned future Company development and growth through successful commercialisation and ultimately, having the potential for shareholders to receive potential gain from equity ownership.

The second, the IP licence agreement, is the cornerstone of the additional elements of the spin-out suite. It provides the grant of rights in the IP from the University and the parties, with the intention of delivering suitable initial protection for the investment and other commitments made to the Company. Supplementing the licence agreement are consultancy / secondment or collaboration agreements to further develop the licensed IP, which can be put in place. Service agreements with Founders should provide the necessary commitment from key individuals who are needed for the future success of the spin-out.

As shown in the diagram above, all these elements and key groups involved are pulled together in the spin-out business plan.