Slow Leaks Can Fill Big Buckets: Tactics for Controlling Equity Dilution in University Start-Ups
Originally presented July 20, 2011

Understanding equity dilution is critically important for any entrepreneur who has who plans on raising seed, angel, and/or venture capital money to help grow their start-up. In the tech transfer and university spinout space, this understanding is even more critical for inventors and the university, both of which typically have a major stake that must be protected.  But all too often, TTOs and faculty start-ups desperate for funding fail to grasp the full implications of term sheets and equity dilution scenarios, only to be shocked later, after several funding rounds, that their shares of the company have gotten an ugly haircut.

And unlike "private" ventures, there are other issues to consider when determining equity arrangements in university start-ups, including IP ownership, faculty involvement, grant awards as a funding source, royalty structure and licensing terms, just to name a few. In short, this is an area that – if handled poorly – can cost universities and faculty inventors big dollars, cause debilitating friction among investors and other stakeholders, and severely hamper a start-ups chances for long-term success. That's why Technology Transfer Tactics Tech Transfer University is sponsoring this high-level program:

Tactics for Controlling Equity
Dilution in University Start-Ups
DVD * On-Demand Video * Print Transcript

We've recruited an A-level team of experts to help you ensure your funding arrangements don't leave you holding the short straw when it comes to equity. Mike Drzal is a veteran attorney who chairs his firm's venture capital practice and handles equity deals from the corporate side of the table, and Zach Shulman is a Cornell business school professor, attorney, and managing partner of a successful venture fund. Both understand the importance of addressing equity dilution in your funding strategy, as well as the key strategies you must follow to ensure you don't get burned. Now, in this hour-long session, they are ready to share their expertise with you. Here's a quick look at what they'll cover:

• Who owns University IP
  • Corporate structure/corporate ownership
  • Faculty (employee) to University (employer) relationship
  • Assignment agreements
• University Spinout Creation
  • Having the right team
  • Faculty involvement in management
  • Managing conflicts with faculty
• Key licensing terms that impact financing
  • Royalty rates
  • Exclusivity and minimum royalty payments
  • Scope of license
  • University equity position
  • Milestone payments and sublicensing fees/restrictions
• Protecting the University from future dilution
  • The "Future Funding" clause
    • Appropriate thresholds for change in equity percentage
    • How dilution affects valuation and pricing
    • Avoiding "us versus them" with founders
    • Simple terms that assure fairness
  • University's rights to further investment
• Protecting founders from dilution
  • Terms to carefully consider:
    • cumulative dividends
    • full ratchet
    • multiple LPs (keep it 1X if you can)
    • participating PS (often hard to avoid)
    • too large and too early distributions
    • funding milestones tied to valuations
    • stock option plans

Your Expert Presenters:

Mike Drzal is a shareholder at LeClairRyan and serves as chair of the firm's Venture Capital practice. He also is a member of the firm's BioPharma and Energy teams. He focuses his practice on and customarily acts as lead counsel in connection with debt and equity financings, mergers and acquisitions, strategic alliances, joint ventures, management buyouts, intellectual property licensing transactions and a variety of other domestic and international transactions.  Mike currently serves as general counsel to a number of emerging companies, including medical device, bioinformatics, pharmaceutical, diagnostics, manufacturing and distribution, alternative energy, medical information technology, internet, and high-tech research and development companies. He also serves as counsel to a growing angel investor network.  He also serves as a mentor at DayOne Ventures, a Blacksburg-based, invitation-only seed stage investment and mentorship program for technology-based start-ups.

Zach Shulman teaches courses on venture capital and law for high-growth businesses at the Samuel Curtis Johnson Graduate School of Management at Cornell University. He is also a managing partner at Cayuga Venture Fund, a venture capital firm located in Ithaca, New York.  Before coming to the Johnson School in 2002, Shulman served as general counsel and chief investor relations officer of Spike Broadband Systems, where he was responsible for general oversight of Spike's legal function, including negotiating and closing strategic and business relationships; strategizing, negotiating and closing fundraising efforts; investor relations; and various human resource matters. While at Spike, Shulman negotiated and closed more $80 million in venture capital financing. He also participates in the university-wide Entrepreneurship@Cornell (E@C) initiative and serves on numerous advisory boards for groups affiliated with Cornell and the local community.