Primer. Charles J. Morton, Jr., Esq. Vasilios Peros, Esq. The Venable LLP logo is a U.S. Registered Service Mark of Venable LLP.

Transcription

1 Tech Transfer Primer Charles J. Morton, Jr., Esq. Vasilios Peros, Esq. The Venable LLP logo is a U.S. Registered Service Mark of Venable LLP.

2 TECH TRANSFER PRIMER Charles J. Morton, Jr., Esq. Vasilios Peros, Esq. TABLE OF CONTENTS I. Introduction... 1 II. Bridging the Gap... 2 III. Does Your Team have the Right Stuff?... 4 IV. Company Legal Structure... 6 V. Intellectual Property... 7 VI. Financing The Venable LLP logo is a U.S. Registered Service Mark of Venable LLP.

3 I INTRODUCTION The region in and around Washington, D.C. provides a vast wealth of technologies developed in our universities and government laboratories and the associated unique opportunities to commercialize such technologies. The effort to commercialize such inventions, often referred to as tech transfer, is an increasingly important part of our regional and national economies. Tech transfer is often a critical element in the formation and development of the businesses we represent. Tech transfer is also an effective alternative for larger, existing companies to develop and maintain their technological edge. The region in and around Washington, D.C. is the home of over 60 government laboratories and universities. Researchers at these government laboratories and universities have historically developed new technology at an impressive pace. Although a portion of such technology may be implemented in various government programs or university teaching experiences, the majority of this technology is not commercialized into products and services that generate positive revenue streams. Among the reasons for this lack of commercialization is the fact that the researcher s focus in not on such commercialization, but rather on the task of developing the basic technology. Technology commercialization is time consuming and must be done in addition to research and teaching priorities. Furthermore, the more entrepreneurially minded researcher, the university and government lab, typically lack the means, and connections to entrepreneurs and existing companies, to facilitate the commercialization of technology. Furthermore, prior to the 1980s, the government generally retained the rights to intellectual property arising out of federally funded research. Under this policy, there was no incentive to develop federally financed inventions for the commercial market. Consequently, inventions through such research simply sat on the shelf. In early to mid 1980s, the Bayh-Dole Act and its amendments were enacted as Congress perceived the need for reliable technology transfer mechanisms. The Act enables small businesses and universities to retain rights to materials and products that they invent under federal funding and to license such materials to companies to facilitate commercialization of technology and development of new products. The Act also requires small businesses and universities to share royalties with the researcher who invented the technology, thereby motivating the 1 TECH TRANSFER PRIMER

4 researcher to assist in the technology commercialization. As a result of the Act, many universities and government labs established tech transfer offices and significantly increased the number of patents issued to them and the number of licenses granted to entrepreneurs and existing companies. Although the efforts of the tech transfer offices have resulted in significant increases in tech transfers, there are still vast amounts of technology that could be commercialized. This Tech Transfer Primer summarizes and discusses the basic issues regarding tech transfer. First, we explore bridging the gap between the university and government lab and the entrepreneur. Second, we discuss the critical elements of an effective team for commercialization of technology. Third, we review the preferred choices of legal structure for establishment of the underlying business. Fourth, we summarize the basic forms of intellectual property and issues in tech transfer agreements. Finally, we discuss the various options available for financing the new venture. In each instance, our goal is to provide a basic overview. A detailed discussion about these topics and many others implicated by tech transfer efforts, is beyond the scope of this Tech Transfer Primer. II BRIDGING THE GAP Much has been written about the importance of leveraging the remarkable blend of public and private strengths in the region in and around Washington, D.C. Unfortunately, when the representatives from the disparate camps actually meet, it seems they are speaking different languages. The very folks who could be helped at local government labs and universities, often discourage the nimble, reactive companies that could actually harness what they create. The discouragement is not intentional, rather it reflects a disconnect in the language of the entrepreneur versus the university or lab employee. Despite noble efforts by tech transfer offices, often the gulf is simply too broad to bridge, and enormous amounts of research and technology remain untapped. Professional advisors and carefully crafted agreements are essential to bridge the gap. Advisors can play an important role in helping companies focus on the strategic benefit of potential partnerships and create ways to realize those benefits. For example, helping companies understand and value the long-term potential of a relationship with a research and technology producing TECH TRANSFER PRIMER 2

5 organization can, at times, be difficult. Equally challenging may be convincing a technology transfer officer of the wisdom of licensing technology to a small company with little experience in product development, manufacturing and distribution. In both instances, the benefits may be more significant than either side would expect. In the case of the long term potential, small companies struggling in this difficult economy may find it difficult to invest the time and resources necessary to build a relationship with a university or a government lab. The uncertain return, perceived insider advantage and fear of the unknown, all conspire to support the status quo. Unfortunately, the real threat to most small companies is an unwillingness to grow. Those that thrive are learning, evolving and seeking new challenges. It is in that process that they find opportunity. There is no better place locally to exercise that process than in the effort to mine tech transfer opportunities. We do mean mine; just as people searched for gold or silver, the local government labs and universities are depositories of wealth to be extracted. It is often hidden, even disguised, but nonetheless real. The challenge for local companies is to find it, dust it off, and reveal its true value. The sources of this research and technology are limited by their own preconceptions. There are often institutional preferences, real or perceived, of dealing with larger companies with well-developed design and development teams and distribution channels. Such companies, however, may not be the best at adapting existing technologies to new applications. They may not be the companies that could actually take the research and technology to the next level. Carefully crafted agreements between labs or universities and entrepreneurs can also help to bridge the gap. The agreements often provide for modest equity, or at least profit sharing in the specific technology and associated rights being transferred. They should define in clear and unambiguous terms the scope of the transfer and any residual rights retained by the transferor. There must be a recognition built into the pricing of the tech transfer of the seminal role played by the private sector company in actually commercializing the technology. Reciprocally, the entrepreneur must value the important role played by the actual inventor of the technology and often it is important to forge a working relationship with that inventor. In short, like in any successful relationship, it must be built on a foundation of mutual respect and an effort to find a structure through which both sides win. 3 TECH TRANSFER PRIMER

6 So today, as you drive past one of our fine universities, or look past the fence at one of our government labs, imagine the hidden resources that are there. They aren t on the surface and it may take some time to find the resources that are the right fit for your company, but they are certainly there. With planning and strategic digging, you may be the one to strike gold. III DOES YOUR TEAM HAVE THE RIGHT STUFF? The road to successful development and commercialization of technology can be filled with unexpected twists and turns. But fortunately, the road can also be very rewarding and profitable. Assembling the right team - the right mix of individuals with technical, business and other critical skills - is an essential step to the successful commercialization of a product conceived in one of our universities or government labs and the success of the company that is formed around it. However, scientists and business managers many times speak different languages and travel in different circles. Despite their efforts, they fail to become part of the same team, lessening the likelihood of success. The successful team will include both experienced technical and business individuals and professional advisors. The team must include the scientist and his technical support team as they hold the knowledge concerning the invention and will be invaluable in product design, development and manufacture. Equally important, the team must also include a business manager who has expertise in managing a company and dealing with a variety of professional advisors and financial matters. Finally, professional advisors such as an attorney, accountant and banker are critical to the success of the team. The benefits of the right team are significant. The completion of the development of the product idea and the subsequent product design, testing and manufacturing will require significant attention from the scientist and the technical team. However, other issues regarding business formation, intellectual property protection, financing acquisition, hiring of employees and staff, and sales and marketing will require equally focused attention. The business manager working with the professional advisors must be skilled in accomplishing these tasks. The relationship of the scientist and the business manager should be complementary. They must function well together to succeed, thereby making the TECH TRANSFER PRIMER 4

7 day to day relationship between them critical. Documenting that relationship and making sure each party understands their role is vitally important. Many legal and financial issues will require the focus of the business manager s efforts. First, the legal structure of the company must be selected. The company s attorneys and accountants can best advise the company on an appropriate structure that provides a shield against liability, affords beneficial tax treatment, and facilitates financial investment in the company. Careful planning is required to assure that control of the company remains with the founding stockholders. Equally important is the acquisition and protection of the company s intellectual property. Many times, the product idea has been developed by a university or a government laboratory. The university or government lab may have filed a provisional patent application or may already have been granted a patent on the product idea. Therefore, the company will license the product idea and the associated intellectual property rights from the university or government lab. The company s attorneys should be able to advise effectively the business manager in negotiating the terms of such license to acquire the technology for use in a broad territory while containing expenses such as initial licensing fees and annual royalties. In the early stages of business formation and product development, the company must also pay close attention to the protection of its trade secrets and trademarks. As the product is developed, the amount of information considered a trade secret will increase. The business manager will want to implement appropriate procedures and legal agreements to protect such trade secrets. Similarly, trademarks that distinctively brand the company and its products will be developed and need to be afforded adequate legal protection. Finally, the company will require financing to achieve its success. The company s accountants can effectively prepare the company s financial statements and clearly define such capital needs. Moreover, the company s attorneys will guide the business manager to the appropriate sources of capital and through the maze of agreements that will be negotiated before the funding arrives in the company s bank account. Although there will be an urge to forge ahead alone, the parties involved must take time to build the right team. Complemented by experienced business 5 TECH TRANSFER PRIMER

8 and legal professionals as an integral part of the team, the scientist will increase his probability of avoiding many of the potholes on the road to success. IV COMPANY LEGAL STRUCTURE The selection of the appropriate company structure is essential to the successful commercialization of technology. From the early stages of technology commercialization, the entrepreneur and his business manager must pay close attention to the selection of the company s structure. The appropriate company structure provides a shield against liability, affords beneficial tax treatment, and facilitates financial investment in the company. In addition, careful planning is required to assure that control of the company remains with the founding parties when the company obtains additional financing from outside sources. A skilled corporate attorney can help to successfully navigate these rough seas. Although there are many choices for the company s structure, the two most used and desirable forms for early stage companies establishing tech transfer opportunities are the S corporation and the limited liability company. First, these legal structures provide essentially the same shield against liability. The liability of the company s stockholders and members will be generally limited to only the amounts that each has invested in the company. This shield from liability is especially important for the founding parties because it can protect from loss of their home and other personal assets. It is important, however, to realize that limitations on liability will likely be determined by contracted guarantees that the founders will be compelled to enter into. Second, the selection of appropriate company structure will avoid the issue of double taxation. In the case of both the S corporation and the limited liability company, income passes through the company to its stockholders and is taxed only once at the stockholder level. Minimizing taxes, while always desirable, is especially important to the operations of the start-up company. Third, these company structures offer effective management approaches. The S corporation will have stockholders, a board of directors and officers. The limited liability company will have members and can be managed collectively by its members, by a managing member or by a board of directors. The entrepreneur and the business manager will typically hold the top positions of the start-up company. TECH TRANSFER PRIMER 6

9 Once the corporate structure is selected, the entrepreneur must pay close attention to the number of shares the company issues to its founders and investors. The entrepreneur may consider selling an interest in the company to his business manager and several key founding parties or employees, thereby giving them a vested interest in the success of the company. However, the number of shares sold is critical to assure that the entrepreneur retains control of the company. In addition, at some point in the future, the company may pursue additional financing from outside investors. It is critical that the founders understand what percentage of stock of the company such investors will want for their investments and plan its initial stock sales accordingly to assure that the entrepreneur retains control of the company. Although the selection of the company structure and the allocation of interests in the company may seem like a paper exercise at first, the founding parties eventually discover that it is essential to effective company operations and to retaining control. V INTELLECTUAL PROPERTY The acquisition and protection of intellectual property is also essential to the successful commercialization of a government or university product, as well as the success of the company formed around the initiative. From the early stages of research and development, researchers and entrepreneurs must pay close attention to the protection of intellectual property rights. A lack of understanding of the technology and the associated intellectual property rights can lead to an unintended partial or incomplete transfer of the intellectual property rights, creating unplanned hurdles to overcome during product development and commercialization. In some cases, debates concerning ownership of intellectual property rights can make negotiations with a university or government lab for the technology transfer difficult, if not impossible. In other situations, the lack of adequate protection after the technology transfer can limit the value and profitability of the product. A skilled intellectual property attorney can help to successfully navigate these rough seas. 7 TECH TRANSFER PRIMER

10 The basic forms of intellectual property rights include trademarks, copyrights, trade secrets and patents. Each form of intellectual property provides its own group of rights and scope of protection. One form, or a combination of forms, of protection will typically be implemented. A trademark is generally a word, phrase, symbol or design used to identify and distinguish the source of goods or services from its competitors. Examples of trademarks include Microsoft for computer operating systems and Compaq for personal computers. Trademark law protects the consumers ability to accurately ascertain the source of goods and services and protects the goodwill associated with products and the businesses for which the marks are used. A trademark should be distinguished from a copyright that protects an artistic or literary work and from a patent that protects an idea or invention. Although one can use a mark without federal registration, there are advantages to federal registration of the mark. For example, the person who obtains federal registration of a mark is presumed to be the owner of the mark for the associated goods and services and is afforded exclusive nationwide use of that mark within a recognized scope of business. Accordingly, such person can prevent other parties from using marks that are confusingly similar to its mark. The mark must be used either in interstate commerce or the person must have an intent to use the trademark in order to be afforded federal registration. Federal registration also provides other significant advantages, such as increased damages, to a party involved in a court proceeding involving matters such as trademark infringement. To best achieve protection of its marks, the company should implement a coordinated trademark strategy. The company should seek the advice of an experienced marketing professional who, working with the entrepreneur and his team, should develop options concerning the branding and marks for the company s new products. The company s attorney should perform a trademark search to assure that the selected marks for the product are not similar to, and do not infringe upon, the marks of another party. The company s attorney should then file for federal protection of the selected marks. A copyright protects artistic and literary works. Copyright protection for a work is generally afforded to those works that fall under the following subject matter categories: literary works; musical works (including lyrics); dramatic works (including music); pantomimes/choreographic works; pictorial, graphic, TECH TRANSFER PRIMER 8

11 and sculptural works; motion pictures/audiovisual works; sound recordings; and architectural works. These definitions are flexible. For example, such assets as software code, manuals, screen displays, audiovisual works and sound recordings may be afforded copyright protection. A copyright in a work is created immediately if the work is original, fixed in a tangible medium of expression, and within the protected above subject matter categories. For example, in the case when an author writes a book, the copyright is created upon the placing of the words on the paper. While there is no formal requirement for an owner of a copyright to file an application seeking to register a copyright, it is highly recommended. Copyright owners enjoy several exclusive rights, including the right to reproduce the copyrighted work; distribute copies of the copyrighted work; prepare derivative works based on the copyrighted work; perform the copyrighted work publicly; and display the copyrighted work publicly. The creator may also assign his rights in the copyrights to other parties or license use of the copyrights to third parties. The creator is granted the exclusive rights for varying lengths of time, generally for author s life plus a specified time period. It is important to note that only the copyright owner has the right to create a derivative work - a work based on, or in other words, derived from, pre-existing copyrighted material. It consists of a contribution of original material to a preexisting work so as to re-caste, transform, or adapt the pre-existing work. For example, modification of copyrighted software or the enhancement of data in a database are derivative works. The intellectual property attorney should carefully review the copyrights associated with the product and the technology transfer from the university and government lab. Because copyrights are created without registration requirements, the university or government lab will typically own the copyrights in the technology being transferred. A patent generally protects inventions and ideas. A utility patent is the most common and covers new and useful inventions of a process, a machine, an article of manufacture, a composition of matter or a useful improvement to the above items. Examples of inventions for a utility patent include medical devices, chemical compounds, processes for manufacturing electronic components, and software-related inventions. More recently, patents have been allowed for 9 TECH TRANSFER PRIMER

12 business methods that involve a procedure or process to perform some business function. For example, a patent can be obtained for a new means of marketing and distributing a product by electronic commerce using the Internet. A patent should be distinguished from a copyright that protects an artistic or literary work but not the ideas in such work. A patent granted in the United States provides the owner the exclusive right to prevent others from manufacturing, using, importing, offering for sale, or selling the invention in the United States. These rights also include the right to prevent others from importing the invention into the United States. Accordingly, any technology transfer which is based on patents generally requires a license of the underlying patent rights. The university or government lab must have clear procedures for the disclosure of new inventions and technology. Carefully crafted employment related agreements should be implemented to assure that the university and government lab does own the intellectual property rights being transferred. Without such employment agreements, there could be confusion over who owns the work. The entrepreneur and his attorney must carefully review the technology transfer agreements to assure that the license includes all of the patent rights required for the operations of the entrepreneur s company. The technology transfer agreements can license all, or only a portion, of the total patent rights held by the university or government lab. Many times, the license granting patent rights will be limited to a specific geographical territory and to a specific field or industry. In addition, the license will typically require the payment to the university or government lab of an initial licensing fee and an annual royalty fee based on the sales of the company. It is critical that the entrepreneur and his team understand the terms and conditions of any license and the associated impact on the company s revenues and growth. Inevitably, the company will also develop its own new inventions and ideas. To best achieve protection of such patentable inventions and ideas, the company should implement a coordinated patent strategy. The company should implement appropriate policies for disclosure of new ideas and inventions as well as carefully crafted employment related agreements which place ownership with the company. The company should also seek the advice of an experienced marketing professional who, working with the entrepreneur and his attorney, should TECH TRANSFER PRIMER 10

13 determine which of the many ideas and inventions should be submitted for formal patent protection. The company s attorney should perform a patent search to assure that the ideas and inventions do not infringe upon the patents of another party and, if appropriate, then file for the patent application. Trade secrets are protected by keeping the ideas, inventions and other confidential information not generally known to the public. Under the Uniform Trade Secrets Act (UTSA), a trade secret is any information, including a formula, pattern, compilation, program, device, method, technique or process that derives economic value from its secrecy and is the subject of reasonable efforts to maintain its secrecy. An entrepreneur can invest significant amounts of money and time in the development of new products, processes and customer lists. The entrepreneur is then faced with the question of whether to protect that intellectual property under a patent or copyright statute or to maintain the intellectual property in a confidential manner as a trade secret. The determination of which course to take is a challenging one, requiring the entrepreneur and his attorney to weigh the effect of public disclosure under patent and copyright laws with the company s ability to maintain secrecy and commercial value through treating the invention or idea as a trade secret. There are several reasons why trade secret protection may be favored over patent protection. First, patents are given monopoly rights of limited duration, whereas trade secret rights persist as long as their secrecy is maintained. The potential for unlimited duration of rights is an attractive attribute of a trade secret. Second, a trade secret inherently is not disclosed to the public, leaving no trail for others to follow. One of the primary effects of patent protection is to provide others with a clear blueprint of the invention. Third, as with a copyright protection, the trade secret protection is immediate. In contrast, the process of patent application and issuance can take several years. Trade secret protection may be the only viable approach if the anticipated period of commercial value of an invention is a very short one. It is a good practice to obtain an employee s written acknowledgement of the confidentiality of the company s information and agreement to not disclose such information. Similarly, such an agreement should be implemented when sharing trade secret and confidential information with a third party. However, 11 TECH TRANSFER PRIMER

14 confidentiality agreements with employees may not be enough to ensure trade secret protection. The company should implement a trade secret protection strategy that also includes: (1) limitations on access to trade secrets, (2) special security for areas in which materials containing trade secrets are stored, (3) specific procedures for monitoring access to materials containing trade secrets, and (4) the implementation of firewalls and security software to protect against unauthorized access to network systems. Although there will be an urge to complete quickly the technology transfer agreement and product development, careful review and understanding of the intellectual property issues associated with the product and the technology transfer are critical to negotiating a complete and cost effective deal with the university and government lab. Continued monitoring and implementation of an intellectual property strategic plan will maximize the value of these intangible assets. VI FINANCING As with any other business, the development of a business, even a product, fueled by a technology transfer requires financing. Working capital is a necessary tool for any developing business. In this regard, companies built upon technology transfers are no different. Capital is needed for such companies to turn ideas into a product and to build the team to turn the product into profits. Financing for businesses comes from an array of sources, from the founders to public sources. It also comes in many different flavors, from debt to equity and many permutations of the sources and flavors. When looking for ways to fund technology transfer opportunities, entrepreneurs should carefully consider all the options. It may be axiomatic to suggest, but nonetheless it is important sometimes to state the obvious, that the first place all businesses should look for funding is with its owners. No one is as likely to see the value in the vision as those who conceived it. And, no one should be prepared to invest in the business if the owners are not. Assuming owners are prepared to make a significant commitment to the business, there are an array of governmental funding sources that encourage TECH TRANSFER PRIMER 12

15 linkages between public sector laboratories and private sector business. Some of these, such as Maryland s Industrial Partnerships (MIPs), do so as an explicit part of their mission. Others, such as the Small Business Innovation Research ( SBIR ) program, do so as a natural consequence of their mission. They exist at both the federal and state level and run the gamut from grants to equity investments. Federal programs include the SBIRs. SBIRs provide varying levels of support, from a phase one grant with a maximum investment of $100,000 to much more in subsequent phases. These dollars are designed to help in the development, testing and commercialization of technology in specific fields. Applications for funding that reflect partnerships between public laboratories and private business fare better than others. These funds, which are not required to be paid back and do not involve the purchase of equity by the government, are arguably the best money any company can receive. States sponsor a number of programs that can help to give such ventures a boost. For example, developed by the Maryland Department of Business and Economic Development ( DBED ), the Challenge Investment Fund and Enterprise Investment Fund Program, offer staged equity investments of not more than $150,000 and $500,000 respectively. Relatedly, MIPs and the Maryland Technology Transfer Fund provide research dollars to engage a professor to commercialize technology developed at a Maryland college or university. This money, which is attached to a modest royalty stream for the funding source, is another inexpensive source of working capital. Although these programs may seem difficult to understand, and here we have only touched on a handful of those that exist, it is worth the investment of time to learn the ropes. In this funding climate, all sources of capital are difficult to navigate. Governmental sources exist for the explicit purpose of helping to develop business opportunities. As a result, it should come as no surprise that such money is typically far less expensive than funds from other sources. The programs, however, should not be viewed in a vacuum. Traditional debt sources, such as senior debt from banks, even SBA backed loans, cannot be forgotten. Nor can subordinated debt from mezzanine funding sources. The challenge is to orchestrate these sources of funds into a something that works for your company, not something that only works on the blackboard. 13 TECH TRANSFER PRIMER

16 For an equity investment to be attractive, companies will have to demonstrate a unique market edge in a potentially significant and lucrative space and an ability to achieve the desired results. The ability to protect the market edge through proprietary technology and intellectual property is essential. Management teams with a history of success are far more likely to receive funding. Anything that can be done to speed the path to profits and to protect the business model along the way, will enhance the possibility of securing funding. This is where technology transfer opportunities provide an edge. The ability to leverage proven technology dramatically reduces risk and therefore increases the likelihood of funding. By working to commercialize a technology that has already been vetted in a government or university setting, a company can enhance the chances of success. Even with the deck stacked in favor of funding, many challenges will remain, including valuation, timing, the desire not to sell at too low a price, and general hesitancy on the part of investors. That is one of the reasons that non-equity based investments, or creative joint ventures, may provide an attractive alternative under the right circumstances. While the structure of such relationships is limited only by the creativity of those setting them up, working with suppliers and customers can often provide a source of funding with which a company can grow. Common relationships vary from encouraging favorable payment terms from customers and vendors who provide, in essence, the capital necessary to do a particular job; to obtaining prototypes in exchange for some future interest. Relationships with competitors with existing sales channels, may also provide an unexpected opportunity to take advantage of the infrastructure created by someone else. Again, while joint ventures are common in many settings, in the arena of technology transfer they can be particularly helpful. The nature of the transferred technology and its level of maturity will obviously affect the ability to create these relationships. Nonetheless, in almost every instance, the credibility and intellectual power behind a technology being transferred out of a university or government lab will enhance its attractiveness to potential partners. TECH TRANSFER PRIMER 14

17 Technology transfers will continue to play an important driving force in our region s economy. In order for the full promise of this opportunity to be realized; however, there must be adequate funding to permit commercialization efforts to thrive, not just survive. Individuals who are working with technologies should look for opportunities to creatively obtain the funds needed to fuel the growth of their business. With discipline, hard work and the right technology, good things are certain to come from the effort. Biographies Charles J. Morton, Jr. is a partner at the law firm of Venable LLP. He was recently recognized as one of the best lawyers in Baltimore when it comes to advising entrepreneurial firms. His practice focuses on representing such firms and the men and women who own and invest in them. He has extensive experience working with the universities and government labs and teaches technology transfer at the Johns Hopkins University. Vasilios Peros is an associate at the law firm of Venable LLP. He focuses his practice on business transactions, corporate law, intellectual property law and technology. His previous experience includes over fifteen years as an engineer and manager at a Fortune 100 corporation. He teaches intellectual property law at the Johns Hopkins University. 15 TECH TRANSFER PRIMER