“Spin-out” and “start-up” are well-known and often used phrases, both in the world of commerce and in the wider media. Programs such as Dragons’ Den have also raised awareness of business angels investing in young companies and start-ups. However, neither “spin-out” nor “start-up” has a precise definition, and the two phrases are sometimes used almost interchangeably. What is the difference?
Well, as the name suggests, a start-up is a business, usually run by a limited liability company that has just started operations. It’s really that simple. Probably still in the process of developing and refining your product or service/proposal, hopefully make a few sales, recruit your first employees, maybe consider your first move from someone’s garage or spare room to a “proper” company headquarters, thinking about getting some investment for growth and generally about starting to conquer the world. It will also be owned by its founders, who often provide the business idea/know-how/intellectual property required to start a business.
The spin-out will look very similar to a start-up, but the key difference is that the spin-out will not only be owned by the founder(s) – it will also have a minority shareholder, which is often a university or other higher education institution (HEI) (sometimes called “mother”). In short, a spin-out occurs when a parent company transfers some of its assets (often intellectual property) to a new company, which is then run and launched as a separate trading entity. A new company that is “spun-off” will usually bring with it some of the parent’s assets and employees (or students if the parent is a university), and these employees/students will generally be the founders. In the US, the Securities and Exchange Commission (SEC) defines a spin-out when the parent company holds a stake in the capital of the newly established company.
At least in the UK, spin-outs are most often created by universities and over the years at Morton Fraser we have been involved in advising many of them. However, we have advised even more start-ups because all spin-outs are start-ups, but not all start-ups are spin-outs.
So what are the practical implications of the differences between start-ups and spin-outs? Well, the key effect is the time it takes to launch a new business. A person or group of founders with a new business idea and potentially some intellectual property needed to run the business can quickly start a new company with agreed shares and go live. A start-up could, if it wanted to, start operating immediately, provided that it opened a bank account and bought insurance. Spin-outs, on the other hand, usually take much longer to start trading simply due to the fact that the “mother” needs to be adjusted and negotiated, both in terms of (i) the basis on which they will transfer their assets to the spin-out ( usually by IP licence); and (ii) the existing rights that a minority interest will give them. It will be necessary for every spin-out (and even some start-ups) to have appropriate agreements, such as the Articles of Incorporation or Shareholders’ Agreement, which set out the various rights and obligations of all shareholders, including the minority shareholder “mother” that spun off the IP or technology . The rules in the articles of association/shareholders would be the same for both start-ups and spin-outs at shareholder and board level, such as how decisions are made, how shares are transferred/issued and how directors are appointed. Most universities have a published spin-off policy that outlines the percentage the university expects to have in the spin-off, as well as the university’s key requirements for each IP license. So founders should have an idea of what to expect before spin-out negotiations begin.