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Is the university spin-off boom worth backing?

Can university-backed businesses succeed where other start-ups have failed?
June 23, 2022

Talk of venture capital opportunities nowadays and thoughts inevitably turn to the pioneers of Silicon Valley. But innovation doesn’t always stem from that particular hotbed of capitalism. In the UK, many start-ups begin life at some of the world’s oldest institutions: universities.

Over the past ten years, the combined value of equity investment deals into companies spun off from UK universities has risen by 527 percent, totalling £11bn of funding. Last year spin-outs took in more than £2.5bn in equity investment, equivalent to almost 10 per cent of total investment into UK private companies in 2021, according to figures from data platform Beauhurst and spin-out investment manager Parkwalk.

Early-stage investing is fraught with risks, but university-linked companies have more staying power than most. Data from Beauhurst and the Royal Academy of Engineering has found that academic spin-outs are more likely to survive than the average start-up. Established UK companies such as Sage (SGE) and Kainos (KNOS) are among those that began life as university spin-offs.

Recent market debuts have proven rocky: DNA sequencing specialist Oxford Nanopore (ONT), which listed last summer, has seen its share price fall 48 per cent since, not helped by rapidly souring attitudes towards early-stage growth stocks. And despite their relative resilience, most university spin-outs do not survive for long enough to become public companies: the average life for such businesses is just nine years.

Statistics like these are why venture capitalists spread their bets widely, in the hope of finding one winner among the many flashes in the pan. And the flow of capital into the sector is helping produce a wider array of potential opportunities – some of which can be accessed by private investors (see below).

Unsurprisingly, much of the capital flowing into spin-offs has been granted to projects developed from universities that make up the so-called UK ‘golden triangle’: Oxford University, the University of Cambridge, Imperial College London, and University College London. Enterprises from the golden triangle have accounted for 32 percent of all spin-offs since 2011.

On a sectoral basis, industries like pharmaceuticals, tech, and service-related enterprises accounted for almost half of all British university spin-outs in the last ten years, yet other sectors – those that rely on future engineering solutions such as AI and big data – are now on the rise.

Companies like bit.bio have merged tech and biopharma to create a synthetic biology solution to “code cells for health” raising £77m in funding in 2021. Carbon Re, meanwhile, uses AI technology to decarbonize cement and steel. The company’s aim is to reduce energy emissions from cement plants that are responsible for 8 per cent of global emissions.

As with the wider investment world, venture capitalists are increasingly interested in “impact and sustainability” focused businesses, according to Dr. Anne Lane, chief executive of UCL Business.

Time horizons are often longer than usual, even for start-ups. A spokesperson for IP Group (IPO), the intellectual property developer, said of the sector: "Often spin-outs are solving complex issues that need greater resources than [for example] ecommerce or B2C companies. They generally spend more on research and development, as they develop concepts into products and this often takes time and money.

"However, when you get to the larger growth rounds you see spin-outs closing funding rounds of similar magnitude to some of the other sectors such as fintech."

But spin-outs are also being bolstered by increased public funding. Last year, government innovation agency Innovate UK issued 197 grants worth £55m, a significant increase from the 24 grants worth £2m awarded in 2012.  Aside from Innovate UK’s growing involvement in the spin-off scene, investors such as British Business Bank, the national economic development bank, have also become significant backers.

The bank announced its £375m “Breakthrough” scheme in July 2021, as it seeks to encourage private investors to co-invest in high-growth opportunities.

“If you were to fund the initial research within a company, the cost of that company becomes significantly greater. That is what public funding does…no VC investment comes unless there is reasonable confidence that the project has commercial traction”, said Diarmuid O’Brien, the chief executive of Cambridge Enterprise.

Not only have government-backed public investments grown, but the equity stakes held by universities during the first year following a spin-out have remained at a moderate 23.8 per cent, and in some cases are falling.

“The university has been asking for smaller and smaller amounts of equity”, Chas Bountra, the pro vice-chancellor for Innovation at Oxford University told Investors’ Chronicle. Bountra adds that Oxford revised its own stake limit to a flat 20 per cent in 2021.

An undiluted equity base is naturally of interest to investors, but so is the vetting process that university spin-off funds undertake to ensure the robustness of their projects through their technology transfer offices (TTOs). TTOs such as UCL Business are tasked with commercializing academic knowledge and are required to identify potential talent.  They use proof of concept funding and translational funding to help de-risk projects.

“TTOs have access to potential, rather than ‘oven ready’ innovations”, UCL’s Dr Lane said. She added that a “significant degree of certainty” in projects can be established via TTO involvement.

“What we are trying to bring together is the right combination of technology, people and markets that generate a successful project”. 

How to access the spin-off story

Investors can look to individual companies such as IP Group; consider generalist venture capital trusts, or look at dedicated Enterprise Investment Schemes (EIS) that focus on university spin-offs. These include the Opportunities EIS managed by Parkwalk (itself part of IP Group), although its high-risk nature means it is predominantly available only to clients with a financial adviser. The University of Cambridge Enterprise fund – another Parkwalk collaboration - launched this week, and is accessible to high net worth or sophisticated investors via the Wealth Club platform. Minimum investments for such funds typically stand at £25,000.