The University Startup Company Law Firm California Massachusetts Florida www.rothmanandcompany.com steve@rot

1. The University Startup Company Law Firm California Massachusetts Florida www.rothmanandcompany.com  steve@rothmanandcompany.com (310) 993-9664 Stephen P. Rothman, Esq. Drafting Win-Win Startup Licenses 1

2. Overview • Why licensing to an academic start-up is different • Taking licensee equity as consideration • Different legal structures for startups • Different financing sources for startups • Dilution • Participation Rights • Board observer rights • Registration rights • Information rights • Litigation • Field limitations and commercialization diligence requirements • Milestones and milestone payments • Restrictions on assignment • Flexibility on terms and conditions 2

3. Why licensing to an academic start-up is different • They typically start with little cash • It’s usually not clear yet if the technology will be commercially viable • They need to attract investors • The investors expect large returns to compensate for the risk • Many of them will fail • Often have a long development phase • Some modest percentage of them will change the world and become extremely valuable • Those that succeed may look very different from when they started: • The business plan • The technology • The people 3

4. Impact of startup characteristics on licenses 4

5. Sample License Provision Granting Equity Licensee agrees to issue to University, in partial consideration of Licensee’s receipt of the licenses granted under this Agreement, that number of shares of common stock representing four percent (4%) of the outstanding common and preferred shares on a fully diluted basis, of Licensee pursuant to an agreed upon stock purchase agreement between Licensee and University. The stock purchase agreement will contain provisions protecting University against dilution of its equity interest in the event the post-money valuation of the A round is less than ten million dollars ($10,000,000.00), and it will also contain a provision for the piggy-back registration of common shares with any other class of stock in an initial public offering. 5

6. Types of Entity • “shares of common stock” • Two types of startup entity, corporation and limited liability company • Corporations issue “stock” or “shares” and are owned by “stockholders” or “shareholders” • LLCs issue “membership interests” or “units” and have “members” • License provisions re equity have to be different for LLC versus corporation (discussed more below) • Which you are dealing with will normally be in the name – Inc. or Corp. meaning corporation and ,LLC meaning limited liability company 6

7. Class of Stock • “representing four percent (4%) of the outstanding common and preferred shares on a fully diluted basis” • Common Stock and Preferred Stock • Convertible Preferred Stock • Participating Preferred Stock • Participating Preferred Stock with cap on participation • Junior and senior preferred stocks • All defined in certificate (articles) of incorporation 7

8. Class of Stock 2 • Cash investors normally get preferred • liquidation preference usually equal to price • With or without cumulative dividends at specified % • With or without participating feature and cap • Founders normally get preferred • What does university licensor get? • Always have seen common stock but consider a preferred stock junior to cash investors but senior to founders • Specific cash liquidation preference is a dollar amount, not subject to dilution, but also not subject to enlargement • May encounter resistance 8

9. “Fully diluted basis” • “representing four percent (4%) of the outstanding common and preferred shares on a fully diluted basis” • What is “on a fully diluted basis?” • Capitalization Table: 9

10. “Fully diluted basis 2” • In the startup world, usually used to mean - assume every share of common stock that could be issued on account of outstanding securities were issued • Generally includes unvested options, and also includes shares issuable upon exercise of options not yet granted but reserved for grant in an employee option pool • Accounting definition more involved than that – Statement of Financial Accounting Standards No. 128 “Earnings per Share” • “Treasury stock method” for options • If using the term, include a definition 10

11. “Fully diluted basis 3” “Fully Diluted Shares” means the number of shares of common stock that would be outstanding if (i) all convertible debt and convertible preferred stock were converted, (ii) all outstanding warrants were exercised, (iii) all outstanding stock options (regardless of whether vested) were exercised, (iv) all shares reserved for issuance under an employee stock option plan or other incentive compensation plan for service providers were issued, whether or not grants of options to purchase such shares have yet been made, and (v) all other outstanding convertible securities or other rights to acquire common stock were fully converted and / or exercised; no deduction from Fully Diluted Shares shall be made in respect of any receipt of option exercise prices or relief from debt upon conversion of convertible debt. 11

12. Dilution • “The stock purchase agreement will contain provisions protecting University against dilution of its equity interest in the event the post-money valuation of the A round is less than ten million dollars ($10,000,000.00)” • X% on a “Fully Diluted Basis” referred to a snapshot of the current capital structure • This clause is talking about future dilution 12

13. What is “Dilution?” • Investopedia definition: “A reduction in earnings per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities. Adding to the number of shares outstanding reduces the value of holdings of existing shareholders.” Does it? • SEC Reg. S-K Item 506 “Dilution” – “where . . . there is substantial disparity between the public offering price and the effective cash cost to . . .” insiders . . . disclose increase in net tangible book value per share to insiders and decrease to purchasers in the public offering • Term is used either to mean mere reduction in % ownership or reduction in value as a result 13

14. Dilution 4 • “The stock purchase agreement will contain provisions protecting University against dilution of its equity interest in the event the post-money valuation of the A round is less than ten million dollars ($10,000,000.00)” • What is wrong with this formulation? • Meaning of “dilution” is not clear • What the “protection” is if dilution occurs is not specified • What is an “A round?” • They mean a Series A Preferred Stock financing • That name comes from the convention of naming successively authorized series of preferred stock sequentially by letters of the alphabet • But that’s not certain to occur. There can be a Series A-1 and Series A-2 financing. There can be a Series 1 financing. • What if the company does gets “strategic” rather than VC financing and issues common stock? 14

15. Revised Anti-Dilution Clause • Alternative A-1 (Corporation, fixed percentage subject to limitation): • Until the Termination Time as defined below, if and when the Corporation issues additional shares of stock of any class, whether for financing, compensation or other purposes, the Corporation shall also issue to the University that number of additional shares of [common] stock as is necessary such that the University continues to own X% of the Fully Diluted Shares. The Termination Time means any of the following events, whichever is earliest to occur: (a) the closing of a round of equity financing with net proceeds to the Corporation of not less than [$2][$3][$W] million] at a per share valuation that is equivalent to valuation of the entire Corporation immediately following such financing not less than [$6][$10][$X] milllion; (b) the Corporation’s receipt of [$3][$5][$Y] million in Strategic Financing [or government grants], that is not in connection with any equity financing; (c) the Corporation’s receipt of revenue from the sale of products or services in excess of [$2][$3][$Z] million; (d) Sale of the Corporation, or (e) five years from the date of this Agreement. [Definitions of Strategic Financing and Sale of the Corporation on final slide] 15

16. Revised Anti-Dilution Clause • Alternative A-2 (Same as A-1 but for LLC): • Until the Termination Time as defined below, if and when the Company issues additional Units or membership interests of any class, whether for financing, compensation or other purposes, the Corporation shall also issue to the University that number of additional [Class X] Units as is necessary such that the University continues to own X% of the Fully Diluted Shares. The Termination Time means any of the following events, whichever is earliest to occur: (a) the closing of a round of equity financing with net proceeds to the Company of not less than [$2][$3][$W] million] at a per Unit valuation that is equivalent to valuation of the entire Company immediately following such financing not less than [$6][$10][$X] milllion; (b) the Company’s receipt of [$3][$5][$Y] million in Strategic Financing [or government grants], that is not in connection with any equity financing; (c) the Company’s receipt of revenue from the sale of products or services in excess of [$2][$3][$Z] million; (d) Sale of the Company or (e) five years from the date of this Agreement. [Use definition of Sale of the Corporation with conforming changes] 16

17. Revised Anti-Dilution Clause • Alternative B (more modest – triggered only by dilution in the sense of sale of issuance of equity for under fair value) (drafted for corporation here) • [Until the Termination Time as defined below], if and when the Corporation issues additional shares of stock of any class, except as provided below, [at an effective price per share of Common Stock of less than $X] [or, for consideration other than fair value], the Corporation shall also issue to the University that number of additional shares of [common] stock as is necessary to compensate the University for the resulting diminution in value of the University’s stock. [Termination concept probably not needed if the fair value formulation is used. Otherwise define the same as in prior slides.] The provisions of this Section X do not apply to (a) bona fide grants of stock or stock options to employees or other service providers in exchange for services [in customary amounts] or [in the aggregate not exceeding [20%] of the Fully Diluted Shares; (b) grants of warrants or other equity in connection with bona fide debt financing transactions with lenders other than Affiliates, . . . [possibly other exceptions] or (c) any other transaction approved by [the University or a director of the Corporation designated by the University] 17

18. Participation Rights • Right to invest cash to maintain pro rata share in future financing (after any percentage anti-dilution has expired) • This is a “gimme” – won’t encounter resistance nor give up other things for the right • Request even if the institution never invests cash in startups • Right can be assigned and has value • Make sure language makes it assignable • Osage University Partners, http://www.osageuniversitypartners.com/ • $100 M fund that invests exclusively in the start ups of our academic partners  — universities, hospitals, and federal labs.   • 8 University Partners (original participants, exclusively assigned participation rights and 45 Associate Partners (non-exclusive rights).  Right to invest is subject to 50% co-investment right by institutions.   • Invests in both early and late stage financings across all technology sectors, including life science, clean energy, advanced materials 18

19. Sample Participation Rights Clause • Pro Rata Participation Rights • If the Company proposes to sell any equity securities or securities that are convertible into equity securities of the Company, then the University and/or its Assignee (as defined below) will have the right to purchase up to that portion of the securities issued in each offering that equals the University’s then current, fully-diluted percentage ownership of the Company on the same terms and conditions as are offered to the other purchasers in each such financing. The term “Assignee” means (a) any entity to which the University’s participation rights under this section have been assigned either by the University or another entity, or (b) any entity that is controlled by the University. 19

20. Sample Participation Rights Clause 2 • Percentage Participation Rights • If the Company proposes to sell any equity securities or securities that are convertible into equity securities of the Company, then the University and/or its Assignee (as defined below) will have the right to purchase up to 5% of the securities issued in each offering on the same terms and conditions as are offered to the other purchasers in each such financing.  The term “Assignee” means (a) any entity to which the University’s participation rights under this section have been assigned either by the University or another entity, or (b) any entity that is controlled by the University. 20

21. Board Observer Rights Allows monitoring of investment Doesn’t entail responsibilities (potential liability) associate with director position Old sample clause: “Licensee grants the Institution the right to have the Director of Technology Transfer or any other person that the Institution may designate as his replacement present as a nonvoting observer at all meetings of the “Board” and all meetings of the Executive Committees of the Board.” 21

22. Better Board Observer Rights Clause Licensee grants Institution the right to have the Assistant Vice President of Technology Transfer or any person that Institution may designate as his replacement present as a non-voting observer at all meetings of the board of directors of Licensee (“Board”) and all meetings of the Executive Committees of the Board. Institution’s Board observer will receive all notice of meetings and documentation, including but not limited to all minutes, reports, agendas, actions, resolutions, and consents that other Board members receive. Observer rights shall survive termination of this Agreement so long as Institution owns at least 1% of the outstanding shares of Licensee stock on a fully diluted basis. Better, but should include all committees, not just Executive Committee, because authority that can be delegated to a committee is not limited by its title. 22

23. Registration Rights • Just because company is public doesn’t mean you can sell all your stock • Restricted Securities covered by SEC Rule 144 • Dribble out rules • Exception after holding period if not an affiliate • May need SEC registration to sell • Only Company can effect the registration • Registration rights permit this • Investor registration rights agreements long, complicated and rarely enforced • “Demand” and “Piggyback” rights • “Underwriter cutbacks” • University license reg rights I have seen limited to piggyback rights • 180 day lockup 23

24. Sample Registration Rights Clause The stock purchase agreement will also contain a provision for the piggy-back registration of common shares with any other class of stock in an initial public offering. Not really. Probably need to define piggy-back. The actual IPO is the least likely offering for selling shareholders to have or exercise registration rights. 24

25. Better Registration Rights Clause, Short Form Could have a full-blown registration rights agreement (may be over-kill). See NVCA IRA Or to save trees and time, see below Note: this one drafted for LLC, but LLCs generally don’t go public in that form If Newco (or a corporate successor of Newco) registers Class A Units (or other securities issued to the holders of Class A Units upon any conversion to corporate form or other reorganization) under the Securities Act of 1933 for sale to the public, Newco (or such successor) shall similarly register the Class B and Class C Units (or other securities issued to the holders of Class B or Class C Units upon any conversion to corporate form or other reorganization), on a pro rata basis, and shall take such other action as may be required to provide the Class B and Class C Units with the same liquidity as holders of the Class A Units. Notwithstanding the foregoing sentence, holders of Newco securities may be required to execute a customary underwriters’ lockup not in excess of 180 days. 25

26. Information Rights • Absent contract or public company context (stock exchange and SEC rules), rights to info defined by state corporate law • May not be very extensive • Put in contract • See form of Investors’ Rights Agreement from a VC deal, or: • Balance sheet, income statement, cash flow statement • Annual, quarterly; monthly? • Annual budget and comparisons to budget as provided to board 26

27. License Provisions re Patent Litigation • Prohibits the licensee from challenging patent validity. • Rationale is prevent licensee from having cake while also eating it • Situations where a licensee would legitimately challenge patent validity, that should be excluded from the prohibition. •   If the validity of the patent has been struck down by a court in litigation with another party.  That leaves the other party free to exploit the technology without paying a royalty, which puts the licensee at a competitive cost disadvantage.  • Where third parties are infringing the patent and the university is not enforcing it.  This would primarily occur only if the university thought the patent were likely invalid.  Again, it puts the licensee at a disadvantage. • Where the challenge is part of a good-faith disagreement about the scope of the patent.  Licensee wish to protect itself against unreasonably broad interpretations of the claims.  27

28. License Provisions re Patent Litigation 2 • Pre-allocating litigation proceeds • Giving the university a larger share of infringement litigation proceeds than its royalty percentage.  • A party taking an exclusive license is buying rights within the exclusive field.  • Whether they end up exploiting rights to the licensed technology by selling products, granting sublicenses or suing infringers, they are still exploiting the same rights they have paid for.  • The split in value between the licensor and the licensee should not depend on the fortuity of whether some third party happens to infringe the patent.  • If pre-allocating proceeds, determine the volume of sales that would have resulted in a profit margin equal to the net proceeds from litigation, after deduction of litigation costs (whether ordinary damages or punitive damages).  • Then the licensor’s share of the proceeds should be the percentage royalty applied to that hypothetical volume of sales. 28

29. License Provisions re Patent Litigation 3 • Refusing to allow the licensee to pull the university into infringement litigation.  • Legal doctrine of “standing” -whether a particular party is entitled to sue for unlawful conduct.  • A patent owner can clearly sue for patent infringement.  • A non-exclusive licensee of a patent clearly cannot sue for infringement (after all, even if they won, the patent owner could just give a license to the infringer, so there is no point in allowing such a suit). •  Courts split on whether an exclusive licensee is allowed to sue an infringer, and in some cases the suit can only go forward if the patent owner is a party.  Hence patent licenses should allow an exclusive licensee to require the patent owner to join an infringement suit.  • Situation where the infringer happens to be a university donor and the university does not consent to being brought into an infringement suit.  Then if the licensee is in a jurisdiction that requires the patent owner to participate in an infringement case, the licensee is ay be unable to enforce rights, making “exclusive” license actually non-exclusive 29

30. Field Limitations and Commercialization Diligence Requirements • Rationale is to assure full exploitation • Some universities require exploitation in multiple potential fields of use as a condition of the licensee’s maintaining exclusivity in each • But early stage investments are very high risk • All fields license versus 5 different fields with milestones in each and loss of exclusivity in each if milestones not met • Someone who is prepared to invest $5 million in a startup technology should reasonably be able to claim all of the economic benefits of the technology, even if they are not pursuing every possible application simultaneously • Different from relatively advanced with relatively certain near-term applicability at the time of license grant to multiple truly distinct fields.  • Investing against tough odds, yet it could turn out that the technology really has commercial potential, but not in the specific field that the licensee first pursued • Possible compromise is compulsory sublicense but only as a last resort, notice, lengthy opportunity to pursue other field 30

31. Restrictions on Assignment • Consent or cash payment is sometimes requested if the license is assigned.  • Investors don’t see rationale • Company that has paid for a particular technology expects to own it whether it turns out to be most fruitfully exploited through the initial licensee or an affiliate or unaffiliated transferee.  • Transfer is generally the ultimate point of the license – the investor seeks to make a profit when the technology, with perhaps some added development, proves more valuable than at the time of the original license. • Stated rationale for requirement is sometimes transfer without adequate consideration outside of entity where institution has equity; but that’s addressed by law of fraudulent conveyance. • Difficult for investor to accept restrictions on assignment other than (i) notice; (ii) assumption of obligations; (iii) perhaps payment of nominal expenses; and (iv) perhaps solvency of assignee. 31

32. Certain Definitions “Strategic Financing” means a transaction or series of related transactions in which (a) the Corporation receives funding for research and development or other purposes related to development of the Corporation’s technology or business, from a potential customer, potential supplier, potential joint venturer or other commercial enterprise, and (b) the consideration given by the Corporation for such funding is not primarily the issuance of equity securities or securities convertible into equity securities. “Sale of the Corporation” means any transaction or series of related transaction as a result of which (a) a sale or other transfer for consideration of 50% or more of the Corporation’s voting equity securities; (b) a sale or other transfer for consideration of all or over 50% in value of the Corporation’s assets (excluding sales of inventory in the ordinary course of business); or (c) a merger or consolidation to which the Corporation is a party, unless at least 50% of the voting equity securities in the surviving or resulting entity continue to be owned by Persons who were stockholders of the Corporation prior to such transaction; in each case ((a), (b) or (c)), where the purchaser or successor entity is not previously an Affiliate (X) of the Corporation or (Y) of any Person holding 5% or more of the voting or economic interests in the Corporation prior to such transaction(s). 32

33. Certain Definitions “Person” means a human being, corporation, limited liability company, partnership, Massachusetts business trust, other trust, estate, or other form of legal entity. An “Affiliate” of a Person is another Person who controls, is controlled by or is under common control with the first Person. 33

34. Questions? Stephen P. Rothman, ESQ. ROTHMAN AND COMPANY, P.A. www.rothmanandcompany.com E-MAIL:steve@rothmanandcompany.com (310) 993-9664 34