Top Tips for Spinning Out Innovations from the NHS

02 July 2014

In his first speech as NHS England Chief Executive in April of this year, Simon Stevens proposed radical change in the way the Health Service staff think and work. His themes included driving innovation from inside and outside the NHS.  

Innovation is the process of developing an idea to meet a technical or operational need, which in the context of the NHS is usually a healthcare need. Innovation in the NHS can take different forms and could be related to process and service management or through clinical developments of medical technology or clinical tools. In addition, the innovation should either save costs or, ideally, also bring in income for the Trust through its commercial application.

With that in mind, spinning out the intellectual property contained in innovations developed in-house with a view to commercialising such IP can satisfy two key requirements of the NHS; using research to advance medical science and ultimately improve patient care whilst also potentially providing an alternative source of funding.

In this article we have provided our top ten tips for NHS Trusts considering the commercialisation of intellectual assets and the issues to consider before implementing the spin-out venture itself.

  1. Consider the types of rights which might be exploited.  NHS Trusts tend to have their particular areas of strength or specialisms so focus developing a culture of research and exploration of potential innovations within that field. Finding new and original uses of technologies, processes etc. within such a field which could have commercial application will create the best opportunity to create distinct intellectual property which can be protectable and potentially valuable.  It is vital to educate staff to identify any barriers to innovation and thendevelop solutions to overcome those barriers.  Conducting a thorough IP audit including diligence on ownership, collaborations, and employment contracts will highlight any such issues.

  2. Ensure all is in place to exploit those rights and that nothing has been done to compromise them. Advise staff on how to protect their ideas so that they can minimise the risks of inadvertent disclosure and/or failure to capture intellectual property, with confidentiality being a large part of the former.  Early registration and subsequent maintenance of rights is also key. Infringement by third parties as well as inadvertently infringing other's rights may also be barriers to moving forward. If innovations are disclosed this may make it harder or impossible to obtain registered intellectual property rights. Examples of disclosures that should be avoided include: presentations to or meetings including staff that are not directly employed by the Trust, articles in professional journals, web sites or peer reviewed journals. Care should be taken particularly if a non-Trust employee has contributed to the innovation.

  3. Identify the best ways to exploit those rights e.g. licensing, product sale and manufacture or sale of rights – sometimes a spin-out may not be the best option.  An idea is only going to be suitable for a spin-out if it satisfies a genuine commercial need in a market which is large enough and valuable enough to attract outside investment from third parties with a real possibility of generating returns on the investor's cash. Some innovations, whilst useful, practical and even valuable in a narrow field of medicine or healthcare, will not be attractive to an investor unless the concept is saleable and scalable. 

  4. Agree how it is most appropriate to transfer the IP into Newco. The newly incorporated vehicle ("Newco") will need rights in the intellectual property to be transferred to it, either by assignment or licence. Many universities and some of the larger NHS Trusts have IP policies around how this can take place, with most favouring licences rather than assignment as this provides a royalty stream as well as participation in any growth of Newco.  In the case of a licence, the Trust remains the owner of the IP but grants Newco rights to use the IP for the contemplated purpose. Clearly there is a conflict between the Trust preserving its rights and Newco acquiring a potentially valuable asset. A compromise would be a licence with an assignment effective upon a clearly defined milestone, such as level of royalties earned or valuation of Newco.  

  5. Consider an appropriate vehicle for Newco, taking into consideration tax implications and the needs of the various parties. The most commonly used corporate vehicle is a limited liability company as the ability to create classes of shares with different rights, rates of return and transfer provisions lends itself to a company with shares and limited liability for the shareholders. This ring-fences the operations of the spin-out business from the Trust and is attractive to external investors.  Limited liability partnerships can be used as an alternative corporate structure, which are attractive to NHS Trust as they are tax transparent, however investors are less used to investing in such vehicles. Favourable tax reliefs, such as entrepreneurs' relief, EIS and seed-EIS are not applicable to limited liability partnerships and the vehicle has to be attractive to commercial investors. The key here is to take advice early.

  6. Ensure that the venture can be funded in the short term and is attractive for investors in the longer term. Initial funding is often from Government grants, early stage venture or seed capital (such as regional development agencies) and business angels.  Fund-raising is often linked to specific development phases and it is likely that multiple rounds of fund raising will be required before the innovation is ready to be marketed and Newco is revenue generating. The dilutive effective of further equity raises therefore needs to be considered. Loans from external providers can be used if available but without assets to secure the debt, interest rates on unsecured debt may be unattractive. Convertible debt instruments are a common alternative to straight equity as the debt provider will rank ahead of shareholders in any insolvency scenario.  

  7. Provide for an experienced board and appropriate incentivisation of management.  As critical to the finance is having the right people to run Newco. Whilst Trust members may play a role, in almost every case professional managers will be required to run the business and may require the incentive of the opportunity to become a shareholder in the future (for example upon achievement of a significant development) so the creation of a share incentive scheme can be very useful. Some Trusts will not require board representation, as they prefer to avoid conflicts of interest, personal liability for directors or due to insufficiency of resources, in which case they can appoint an observer to the board.  Bear in mind the potential availability of tax efficient options such as EMI options (Enterprise Management Incentives).

  8. Determine what key minority protections the Trust will require.  The Trust will likely have minority stake of less than 25% of the equity. Although the Trust won't therefore have control over the day-to-day decisions, the shareholders' agreement will reserve key decisions to the shareholders to determine thus giving the Trust some negative control rights. These matters will typically be limited to big ticket items which go the fundamentals of the business or its value.  It may also be necessary to include protections around safeguarding the reputation of the Trust. If Newco is operating from within the Trust or using Trust resources, it will be important to ensure that these arrangements are suitably arms' length and documented.

  9. Be flexible when it comes to considering and planning for exit alternatives. Depending on the nature of the innovation, the market conditions and the needs of the investors, most investors will want some thought to have been given to the exit route, be it a disposal or listing.  Exiting Founders is also something to bear in mind.  If the founder leaves, should they keep some or all of their shares or be required to sell them and if so, at what price. A common trend is for shares to vest over a period of time, such as 3 years on a straight line monthly basis, allowing these shares to be vested free of obligations to transfer on leaving.

  10. It's worth thinking about where disagreements might arise, how these can be avoided and how any disputes that do arise will be dealt with. Alternative dispute resolution such as mediation or arbitration may be appropriate, after internal escalation perhaps. More draconian provisions such as put and call options can be used but are likely to favour those with the deepest pockets!