Recently, the Ewing Marion Kauffman Foundation unveiled the Carolina Express Licensing Agreement (CELA), which is a standard contract for universities to use when a faculty member, staff member or student starts a new company to exploit a university-assigned invention.
The Foundation argues that this uniform agreement will help create more university spinoffs, but I’m not so sure. While a standard contract facilitates new company creation in a couple of ways, the cons of such agreements outweigh the pros.
Benefits of the Agreement
The Foundation should be applauded for providing universities with a prototype agreement that can be used as the basis of discussion between university inventors and technology licensing offices. The CELA will allow academic entrepreneurs to enter into negotiations with universities with a better understanding of how spinoff company creation works, and the types of agreements that underlie it.
Why the CELA Can’t Be Used as a Standard Agreement
While the CELA might be a useful educational tool, too much is missing from it for universities to adopt it as a standard agreement.
First, the contract proposes a common royalty rate for all startup company licenses: two percent of net sales, unless the invention is part of a clinically approved product, in which case the royalty rate is one percent of net sales. Unfortunately, a standard royalty doesn’t work for university spinoffs because it fails to take into account the differences in rates that exist across technologies. In reality, these percentages are prohibitively high for some products and unacceptably low for others.
Moreover, the CELA offers these royalties in return for an exclusive license to a field of use. This approach is problematic because field of use varies a lot across inventions; and paying two percent of net sales for the rights to a broad field is very different than paying that amount for the rights to a narrow field. For example, paying a two percent royalty to license a semiconductor to computer makers is very different than paying that amount to license a tire wear indicator to tire manufacturers.
Furthermore, university inventions are not equally important to all products that build upon the licensed inventions. For some products, the university invention may be the only technology that needs to be licensed, while for others many additional patents might also be required. If one invention is central to the creation of a product, while another is just one of many necessary technologies, then why should both inventions pay the same royalty rate?
Second, a big component of the payment for a startup company license – equity investment – is missing from the CELA. Instead, the CELA proposes that universities receive a fee of 0.75 percent of the value of the company’s fair market value upon liquidation.
However, universities often receive equity stakes in lieu of licensee payments of patent costs because startups are cash constrained. Equity investments in lieu of patent costs do not appear to be possible under the CELA, which holds that the “licensee shall bear the cost of all reasonable, documented patent expenses” including those made prior to the execution of the licensing agreement.
Moreover, the equity stakes that universities take in spinoffs vary widely across institutions and technologies. The CELA doesn’t consider that there might be reasons for this variation. The Kauffman Foundation’s description of the CELA simply says that “cases exceeding 15 percent” are “excessive.” But universities should get greater or lesser ownership shares depending on the role that the university will play in the further development of the technology, the alternatives that the university has for licensing the technology to existing companies, and whether the license is exclusive or non-exclusive.
Third, the CELA makes all licenses to spinoffs exclusive. While exclusive licensing generally makes sense, there are situations in which non-exclusive licenses are better. For instance, if the invention is a broad platform technology, universities would probably get the technology to market faster by non-exclusively licensing it to multiple companies.
Fourth, the CELA doesn’t accommodate university financing of its spinoff companies. Some universities offer cash or lines of credit to their spinoff companies, but there is no discussion of these financing arrangements or their terms in the CELA. A spinoff seeking a university investment or line of credit would therefore not want to make use of the standard agreement.
Fifth, the CELA makes no mention of university representation on the company’s board of directors. However, in many cases, universities seek board seats to help guide their spinoffs and preserve their interest in the development of their licensed technology. So any institution concerned about post-investment governance wouldn’t want to use the CELA.
In short, the CELA helps to facilitate the creation of university spinoffs by offering a standard document for discussion between faculty entrepreneurs and university technology transfer officers. But, it can’t be the contract that institutions use for all of their spinoffs.
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Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool’s Gold: The Truth Behind Angel Investing in America; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.