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Licensing Commercial Rights to Start-up Companies

## Philosophy

As part of its Technology Transfer effort, Sandia National Laboratories
licenses commercial rights in intellectual property to private
companies. The goal of such commercial licensing is two-fold: (1) to
enhance access to commercially proven technologies for the benefit of
the Laboratories' DOE programs and (2) to encourage the adoption of
Sandia technology for the benefit of the U.S. economy. Some of the
intellectual property licensed has the potential to transform
industries. These "disruptive" technologies are typically immature, and
their commercial applications are often speculative. They are also most
likely to be developed by start-up companies. The challenge, then, is to
structure license deals that encourage the emergence of new companies
while contributing to Sandia's mission success and providing the
Laboratories with a fair return on the potential commercial value of the
technology.

To this end, Sandia has adopted a business practice of combining
commercialization milestones with the structuring of license
consideration as a "bundle," including up-front fees, royalties, and
equity (when appropriate). This practice offers a balanced approach that
encourages the commercialization of laboratory technology, forms a
common basis by which Sandia and the company jointly manage the risk of
commercialization, and provides modest near-term license income with
which to reward inventors and defray intellectual property expenses. The
business practice is flexible. Depending on the perceived risk of
commercialization, Sandia considers a range of license alternatives when
negotiating with resource-constrained start-up companies, including the
freedom to trade-off the various elements within a "bundle" of financial
consideration. Start-up companies can also reduce the burden of up-front
fees by agreeing to early commercialization milestones, including early
product introduction.

The Morella amendment to the National Competitiveness Technology
Transfer Act of 1989 clearly establishes the philosophy of "reasonable
\[financial\] consideration" for rights to Sandia intellectual property.
A "fair" return on the commercial value of the technology is arrived at
through license negotiations, which are guided by the principles of
comparable value in the marketplace, program benefits, and an assessment
of risk (e.g., the risk the technology will sit on the shelf and lose
value over time). While the government has paid for most of the
inventions arising from the R&D at the Laboratories, Sandia has the
responsibility to manage those assets for the benefit of the DOE, the
Federal government, and the domestic economy, just as the U.S. Forest
Service does with the timber and mineral assets on public lands.

The Philosophy above and much of the discussion that follows applies to
large businesses as well.

## License Consideration

*[Up-front cash payments]{.underline}* enable Sandia to realize
immediate financial benefits from its licensing program while
establishing a threshold that separates serious clients from those
uncommitted to finalizing a deal. Financial benefits accrue to the
Laboratories from distributions to inventors, authors, and Sandia's
technical organizations for future R&D and technology maturation. Early
financial rewards to the technical organizations, inventors, authors,
and other contributors also are strongly linked to their continued
support for our intellectual property management efforts. From the
licensee's perspective, up-front cash payments encourage businesses to
be selective about the technologies and fields-of-use they wish to
license. When licensing to a start-up company, Sandia ties up its
intellectual property for a relatively long period of time before the
prospects of commercialization success are understood. During such time,
the value of the intellectual property could erode because of competing
technologies and market forces. In some cases, as with cash-strapped
start-up companies, Sandia is willing to trade some of the up-front cash
payments for equity. The trade-off decision is based, in part, on the
strength of the business plan, the program benefits, and the perceived
risk of the venture.

*[Royalties]{.underline}* on commercial sales are another means of
joining the interests of the Laboratories and the licensee by sharing
risks and allowing Sandia to participate in the upside potential of
successful commercialization. Despite a perception by some licensees
that royalties are a cost that operates in opposition to an equity
position, Sandia's philosophy is that royalties are a cost of sales
since the company's obligation to pay arises only when commercial sales
occur. Sandia maintains a fundamental belief that the Laboratories and
the licensee should share in the commercial success of products that
incorporate Sandia intellectual property.

*[Equity]{.underline}* represents a long-term investment by the
Laboratories in the licensee's company. When converted through a
liquidation event, equity enables Sandia to generate funds for R&D and
technology maturation. Equity sharing within the Laboratories also
assists in retaining and attracting staff with critical skills, inspires
all Sandians to support partnership and commercialization activities to
accomplish their mission objectives, and contributes to an enhanced
perception of the Laboratories as an exceptional place to work. To date,
Sandia has taken equity in several start-up companies. When licensing
technologies to start-up companies, Sandia often will trade some of the
up-front cash payments and royalties for an equity interest. However,
the prevailing practice at the Laboratories is to resist taking all of
the license consideration in the form of equity because of the need to
manage the risk. First, Sandia typically takes nonvoting founders'
common stock and consequently has no say in the management of the
company. Also, in an equity-only license there is a possibility that
bottom-line profitability across all of the company's products will not
reflect the true market success of the Laboratories' licensed
technology. Further, equity in a start-up company may be illiquid for
many years. Sandia's strategy of "bundling" license consideration allows
it to mitigate some of these risks.

*[Other license considerations]{.underline}* might include equipment
donated or made available to Sandia and access to R&D rights to licensee
technology.

**[Commercialization Milestones]{.underline}**

Sandia incorporates commercialization milestones into each license to
motivate the licensee to perform in accordance with the provisions of
its commercialization plan. Milestones, which may include prototype
development, commercial product introduction, and sales targets, are
usually adopted from the company's business plan. Minimum annual royalty
payments challenge the licensee to commercialize the technology in a
timely fashion and avoid overextension in terms of licensed technologies
and use rights.

# Conclusion

License agreements with start-up companies offer Sandia the opportunity
to mature its disruptive technologies and develop reliable suppliers of
commercially proven technologies to satisfy its mission requirements.
Commercial licenses also generate short-term and long-term revenues that
can be used to reward Sandians' intellectual creativity, support
discretionary R&D, and attract and retain high quality talent. Sandia
has developed a flexible, yet systematic, licensing approach that
enables its licensees to succeed, satisfies various business conditions
critical to both parties, and meets the Laboratories mission obligations
to the DOE and NNSA.

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Sandia is a multiprogram laboratory operated by Sandia Corporation, a
Lockheed Martin Company, for the United States Department of Energy's
National Nuclear Security Administration under contract
DE-AC04-94AL85000.