Spin out companies and shareholders agreements: main issues

In this article Dr Maria Anassutzi, Intellectual Property Expert, further explains the contractual documents involved when setting up a joint venture company in order to transfer to it and commercially exploit through it valuable intellectual property whether this happens between commercial organisations or between a university’s research division and a commercial spin-out company or a combination or both.

In a transfer of technology situation where intellectual property is being transferred, a spin-out company generally a joint venture (Newco) will be set up and each of the parties will take an interest in it for nominal value. Each of the parties may invest in different kind. In any case, all the parties will need to consider the tax implications carefully and although tax relief is available on certain conditions.

The relief does not apply at all if the avoidance of tax or national insurance contributions is one of the main purposes of the arrangements. The shareholders agreement will also include provisions dealing with the shares subscribed or to be subscribed by the parties and the consideration payable by them; the intellectual property agreement to be entered into by the university and Newco; (iii) any other documentation to be entered into by Newco to deal with the terms of employment, engagement or provision of services by the university; and the appointment of any additional directors (including the university director and/or the investor director).

The shareholders agreement will also address day-to-day management issues, for example, whether the investors would want to appoint a director (or two) so that they are represented to the board of Newco. Such a director’s role is to monitor the running of Newco and how the investment is used. This can place the investor’s director in a delicate position, because as a director he owes a duty to Newco as a whole rather than to those shareholders who appointed him. The universities tend to appoint an observer to the board and, in particular, to be copied in on all relevant resolutions, notices and minutes, and the associated financial information. This is often due to a concern of possible conflicts of interest, insufficiency of resources and the risks of its appointees’ assuming directors’ duties and liabilities in relation to businesses in which they may not be actively involved on a day to day basis.

Generally, the investors and the technology owner/university will have a minority stockholding in Newco. They will be given the right to veto decisions in certain key areas of Newco’s business. The areas in relation to which such a veto exists are matters for negotiation, but generally include change the nature of Newco’s business or its constitution; sale of Newco; acquisition of another business or assets which would constitute a large proportion of the expanded company; new investment which would dilute the existing shareholdings of the parties; or winding up Newco.

Investors and the university will require certain rights of information to enable them to monitor the business of the spin-out company and their investment in it. These rights will typically cover the right to:
(i) receive annual accounts and management accounts;
(ii) receive and approve the annual business plan or budget of Newco;
(iii) receive periodic reports and reviews of the business together with minutes of board and committee meetings; and
(iv) access (with advisers) to the company’s records and facilities.

When technology transfers occurs directly to industry, the owner of the technology and intellectual property in it will be required to warrant that it owns all the rights granted to Newco free from any third party rights or claims.

However, very often the intellectual property owner (whether a university or other commercial entity) will try to limit or qualify any such warranties. In fact, it is usually only the individuals who are forming the spin-out company who are in a position to be aware of any likely third party claims in respect of the relevant intellectual property.

Consequently, the risk tends to fall on such individuals (professors, researchers etc), who will be asked to provide warranties to both the intellectual property owner and the investors. In addition to the warranties in relation to the relevant intellectual property, other areas in respect of which warranties will be sought include Newco’s business plan on which the investors and intellectual property owner may have relied, the details of Newco (including existing shareholdings), Newco’s ability and authorisation to enter into the transaction, the solvency of Newco and usually (since the spin out is so early stage) that Newco has no material debts.

Although warranty exposure may be limited and capped to a fairly low financial sum for such individuals, such as a multiple of their annual salary or fees to be received from the company, it is still necessary to ensure that a proper disclosure is made to the investors at the appropriate time, as they may seek specific indemnities on these points.

As the continued participation of the individuals will be paramount for Newco, the investors and possibly, the intellectual property owner, will be keen to secure their long term commitment and prevent the individuals from doing anything to damage the interests of Newco. This can be achieved using a combination of service agreements or consultancy contracts.

All articles are for general purposes and guidance only and do not constitute legal or professional advice.