Fri 02 Dec 2022

Spin-out or start-up - what's the difference?

'Spin-out' and 'start-up' are well-known and frequently used phrases, both in the world of commerce and also more widely in the media. Programmes like Dragons' Den have also raised awareness of business angels investing in young companies and start-ups. However, neither 'spin-out' nor 'start-up' has an exact definition, and the two phrases are sometimes used almost interchangeably. So, what is the difference?

Well, as the name suggests, a start-up is a business, usually carried on through a limited company, that has just started-up. It really is as simple as that. It will probably still be in the process of developing and refining its product or service/proposition, hopefully making a few sales, recruiting its first staff, possibly considering a first move from someone's garage or spare room to some 'proper' business premises, thinking about raising some investment for growth and generally beginning to make its way in the world. It will also be owned by its founder(s) who will often have provided the business idea/know-how/intellectual property required to get the business off the ground.

A spin-out will look very similar to a start-up but the crucial difference is that a spin-out won't just be owned by its founder(s) - it will also have a minority shareholder which is quite often a university or other higher educational institution (HEI) (sometimes known as 'the parent'). In short, spin-outs occur when the parent moves some of its assets (often intellectual property) into a new company which is then run and launched as a separate trading entity. The new company that is 'spun-out' typically brings with it some of the parent's assets and employees (or students, if the parent is an HEI) and those employees/students will generally be the founders. In the USA the Securities and Exchange Commission (SEC) defines a spin-out as when the parent has a share in the equity of the newly formed company.

In the UK at least, spin-outs are most common from HEIs and over the years we at Morton Fraser have been involved in advising many of them. However, we have advised on even more start-ups because all spin-outs are start-ups, but not all start-ups are spin-outs. 

So what are the practical effects typically of the difference between start-ups and spin outs? Well the key effect is the time taken to get the new business up and running. An individual or group of founders with a new business idea and potentially some intellectual property needed for the business could incorporate a new company with their agreed shareholdings quickly and be off and running. A start-up could, if it wished, begin trading immediately, subject to opening a bank account and arranging insurance. However, by contrast, spin-outs typically take much longer to get trading simply because of the fact that 'the parent' has to be accommodated and negotiated with, both in terms of (i) the basis on which they'll transfer their assets to the spin-out (usually by way of an IP licence); and (ii) the ongoing rights that their minority shareholding will give them. It will be imperative for any spin-out (and indeed some start-ups) to have appropriate agreements in place, such as articles of association or a shareholders agreement which set out the various rights and obligations of all shareholders including the minority shareholder 'parent' which has spun-out the IP or technology. The principles contained in articles of association/shareholders agreements would be the same for both start-up and spin-outs at shareholder and Board level, such as how decisions are made, how shares are transferred/issued and how directors of the company are appointed. Most universities have a published spin-out policy which sets out the percentage shareholding that the university expects to have in the spin-out, and also sets out the university's key requirements for any IP licence. The founders should therefore have an idea of what to expect before spin-out negotiations begin.

Morton Fraser provides legal advice to a number of start-up and spin-out businesses. Whether you’re the founder of a spin-out or a start-up, we can guide you through the legal issues and make sure your business is set up in such a way that you can concentrate on growth and expansion with confidence. 

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