February 1, 2005 (Vol. 25, No. 3)
Innovation and Commercial development
Biotechnology companies at all stages of growth need a robust technology platform and capital. StartUpCo, a hypothetical emerging biotech company, needs a technology platform and instant credibility to attract investors. Typically, StartUpCo looks to an academic or biomedical research institution, such as MediSchool, to fill these needs.
An established, private company, like Pre-IPOCo, needs a product pipeline as well as real-time revenues to remain viable and execute its exit strategy. Pre-IPOCo is likely to look to academia as well as StartUpCo for acquisition or pipeline expansion opportunities, but Pre-IPOCo also will seek other revenue-generating opportunities such as strategic alliances.
Enter PublicCo, which is, in turn, receptive because PublicCo recognizes that Pre-IPOCo is peddling innovationsomething PublicCo can never have too much of.
Even though each companys particular business strategy differs, the real objective is the same access to technology. Each company could benefit immediately from a technology license. While this article is not a primer in technology licensing, it does address some recurring issues in biotechnology licensing transactions, namely, reservation of rights, sublicensing, and royalty stacking.
Reservation of Rights
For policy and regulatory reasons, academic and research institutions require continued access to the licensed technology, even in the face of an exclusivity provision. Access is typically limited to researchonly use by the institution or any other nonprofit organization that requests access for such purposes. However, in some cases, such access can effectively render an exclusive license non-exclusive.
Imagine that Dr. X of University Y requests access to exclusively licensed drug discovery technology, but unbeknownst to the institutional licensor (MediSchool), Dr. Xs lab receives research funding from PublicCo. Based on appearances, Dr. X is conducting noncommercial research, so access is provided.
However, use of the technology in drug discovery research for PublicCo arguably renders exclusivity moot. Under this scenario, StartUpCo, as the licensee, has all of the financial obligations of an exclusive licensee but no exclusivity.
To avoid this, StartUpCo can negotiate language governing access and dissemination of the licensed technology. For example, research purposes can be defined to prohibit access to researchers for use in current or future commercial funding agreements.
Additionally, the licensor can be requested to refer all inquiries to the exclusive licensee who is, in turn, obligated to disseminate the technology only to qualified researchers. Now the exclusive licensee has a reasonable degree of control and can stand between the licensor and any commercial beneficiary.
In its early days, when StartUpCo negotiates its founding license with MediSchool, the business needs of future sublicenseesPre-IPOCo and PublicComust be considered. Sublicensees expect assurances that, if the StartUpCo license is terminated for any reason, the rights of Pre-IPOCo and PublicCo will continue uninterrupted.
StartUpCo should also foresee whether Pre-IPOCo and PublicCo will require the ability to grant further downstream sublicenses. The best practice for StartUpCo is to negotiate with MediSchool for these rights up-front.
Managing revenues derived from sublicensing activities can also be a challenge for StartUpCo. A company of any size needs to structure sublicense revenue sharing in a rational way based on its current business plan, yet remain flexible enough to accommodate its evolving business.
One revenue model contemplates that StartUpCos licensor receives both a fixed earned royalty on each product sale by StartUpCos sublicensee and a flat percentage of all other revenues received by StartUpCo from its sublicensee, such as license issue fees and milestone payments.
Another model would simply be a flat percentage of all sublicensing revenue, whether the source is earned royalties on product sales by the sublicensee, issue fees, or milestone payments.
StartUpCo must consider which allocation would better suit its business needs. In either case, StartUpCo may wish to negotiate payment of a lower percentage of sublicensing revenue to MediSchool at some future date or event when the value of the sublicense has been significantly enhanced by StartUpCos own improvements to the licensed technology.
The road to market is long, and StartUpCo will probably enter into multiple licenses with multiple parties for complementary technologies. The initial license with MediSchool for the founding core technology will attach a royalty payable to MediSchool as the institutional licensor on each licensed product sold.
Given that market entry and freedom to market can typically require additional licenses and royalty fees stacked on the licensees initial royalty obligations, the initial royalty rate has implications for every future license, as well as future partnerships and rounds of venture financing.
For example, StartUpCo may first license a core drug discovery tool, and then a drug delivery system and various compounds. If the royalty demands of that first license are too rich, StartUpCo will be paddling upstream for years, perhaps trading off equity shares or cash milestone payments to minimize royalty rates in subsequent licenses, or perhaps losing new venture funding because the profit outlook is grim.
If, however, that first license and each subsequent license contain royalty-stacking provisions, StartUpCos royalty burden could be less troublesome.
One type of royalty-stacking relief permits StartUpCo to credit a portion of its payments for future licensed technologies included in the product against the product royalty payments due to MediSchool. The institutional licensor generally will require some minimum royalty rate (such as 50% of the original rate) to protect itself against unfair erosion of its royalty stream.
Another version of a royalty-stacking provision protects the licensor from disproportionate royalty loss by only permitting such a credit if total stacked royalties exceed some ceiling.
A similar stacking issue can arise when multiple milestone payments are due to multiple licensors, such as upon a filing with the FDA. Ultimately, licensors should understand that cumulative royalty payments by StartUpCo could become so prohibitive that the licensee will be forced to abandon the product. That is an opportunity lost for all involved.