Becki DeGraw on spinouts, IP licensing & clean exits | Wilson Sonsini Startup Legal Basics

Episode Summary

Executive Summary: The episode explains startup spin-outs: when a technology, project, or IP developed inside one company is separated into a new entity, or licensed out instead of sold. The hosts stress that these deals are highly fact-specific and require careful structuring around equity, IP ownership, confidentiality, fiduciary duties, and investor expectations to avoid cap table and diligence problems later.

Main Topics: Why spin-outs happen: Spin-outs are used when internal technology is promising but no longer fits the parent company’s strategy, or when a team wants to build it as a standalone venture. Equity and deal structure: The discussion focuses on how parent and new company ownership is negotiated, with equity often the key consideration but sometimes supplemented by cash, earnouts, royalties, or milestones. IP transfer vs. licensing: The speakers compare full assignment of IP to exclusive or limited licensing structures, noting that licensing was more common in some deal environments but can create tax and operational complexity. Investor and cap table concerns: A major warning is that spin-out terms must leave the new company attractive to investors; overly large parent stakes can distort incentives and make future fundraising difficult. Legal and fiduciary risks: The episode highlights confidentiality, customer ownership, conflicts of interest, and fiduciary duties, especially when founders or directors are moving assets out of a company they helped build. Practical separation process: The hosts emphasize that spin-outs are like a corporate divorce: they require a clean break, documented agreements, and careful handling of assets, people, and ongoing business relationships before anyone launches the new venture.

Key Arguments: Spin-outs are often the best path when a project has value but does not fit the parent company’s long-term strategy. The parent company should usually keep a minority stake large enough to benefit from success but not so large that it discourages new investors or founders. A good spin-out must be judged by future scenarios, not just present value; if the new company becomes a unicorn, the original company should still feel it received a fair return. Equity is the most common form of consideration, but cash, royalties, and milestone-based earnouts are also used, especially in university IP transactions. The biggest deal risk is not just ownership of the asset, but everything surrounding it: confidentiality, customer relationships, licensing back rights, and employee/contractor continuity. Founders should not start operating the new company until the separation is fully papered to avoid breach of fiduciary duty or confidentiality obligations. Investors will diligence the chain of title and the spin-out process heavily; a messy separation can block financing even if the technology is strong.

Data Points: Suggested parent equity stake in spin-out: 20% - Jason says a common target is for the existing company to keep 20% and the new team keep 80%. Suggested new team equity stake in spin-out: 80% - Used as the reciprocal example of a balanced spin-out structure that still motivates founders. Alternative ownership splits discussed: 25/75 and 30/70 - The hosts mention other common negotiated ranges depending on circumstances and value creation. Example of broken cap table: 25% - Jason describes an accelerator company that gave 25% of the company to the people who built the first app version, which made the cap table unmarketable to investors. Back-end buyback example: Right to buy back at a $10 million valuation - Proposed remedy to reset an over-diluted founder/developer arrangement. Example cash consideration to builders: $50,000 - Suggested as partial compensation for work that originally cost about $100,000 to build. Original build cost example: $100,000 - Used to frame the proposed settlement for early app builders. Potential upside mentioned: $250,000 - Jason says the developers could make about $250,000 under the proposed structure. Licensing use period example: 2 years - Illustrative example of a temporary infrastructure license during a spin-out. Non-compete / competitive restriction example: 5 years, 7 years, or 10 years - The hosts note long restriction periods may be negotiated to keep the spin-out from competing directly with the parent. Suggested investor diligence allocation: Number one diligence exercise - Jason says investors will first scrutinize the chain of title and how the spin-out was done.

Pivotal Quotes: "It's a divorce. It's a separation. Let's be honest." — Jason: Used to explain that spin-outs require a real legal and operational breakup, not a casual transfer. "Don't break the cap table." — Jason: A central warning that poor equity planning can make the new company uninvestable. "They are going to diligence the heck out of how did this get spun out?" — Jason: Describes what future investors will focus on before funding the new entity.

Implications: Founders should treat spin-outs as high-stakes restructurings, not informal handoffs. Clean IP title, documented separation, and investor-friendly ownership are essential for fundraising and avoiding legal disputes.