The Art of Corporate Spin-Outs: When to spin-out? How to spin-out?

In the volatile economic environment of today, if done right, innovation isn’t just a buzzword; it’s the lifeline of the company. Corporations are constantly seeking ingenious ways to breathe life into groundbreaking ideas, and spin-outs are just one of many ways in which companies can make innovation a viable proposition.

“Spin outs” typically refer to the process of a new company being created from an existing organization, often a university, research institution, or a larger corporation. This new entity, the spin-out, usually originates from the research or innovations developed within the parent organization. The purpose of a spin-out is to commercialize these innovations, turning them into viable products or services in the market. Spin-outs are common in industries where innovation and research play a crucial role, such as technology, biotechnology, and pharmaceuticals.

Therefore it is safe to say that spin-outs are the place corporate innovation management meets entrepreneurship head-on. But doing spin-outs right is easier said than done. An HBR research that looked at more than 350 public spin-outs valued at greater than $1 billion between 2000 and 2020, found that 50% of companies pursuing a separation fail to create any new shareholder value two years down the road, and 25% destroy a significant amount of shareholder value in the process.

Reasons why spin-outs make sense

In spite of poor success rate, for the following reasons, spin-outs are still a very tempting proposition for corporations and universities alike: 

1. Focus: Large organizations often have diverse interests. By spinning out a specific innovation, the new company can focus solely on developing and commercializing that innovation.
2. Entrepreneurship: Spin-outs allow researchers and innovators to become entrepreneurs, giving them the opportunity to bring their ideas to market and potentially benefit financially from their work.
3. Funding: Spin-outs can attract external investment, including venture capital, which might be more challenging for a department within a larger organization.
4. Agility: Smaller, newly formed companies can often respond more quickly to market demands and changes, allowing for greater agility in product development and marketing strategies.
5. Risk Management: If an innovation fails in the market, it doesn’t directly impact the parent organization’s reputation. The risk is confined to the spin-out entity.
6. Innovation Ecosystem: Spin-outs contribute to the overall innovation ecosystem of a region or industry, fostering competition and driving further advancements.

Pitfalls to be aware of when preparing a spin-out

But regardless of how tempting doing a spin-out is there are some pitfalls the mother company needs to be aware of from before even considering the move: 

1. Some companies decide to spin-out ventures that simply are too close to the core of their main businesses. This was the case of Staples.com where a simple business model innovation exercise around ‘channels’ has transformed into a massive spin-out fiasco that had to be stopped by the shareholders.
2. Sometimes short termism trumps long term strategic thinking. Instead of thinking of the spin-out as a business itself, the mother company uses it to write off debt, liabilities or use it as collateral to borrow money for the core business. 
3. Some companies decide to spin-out entities that can’t possibly live by themselves as they are not being spun out with everything they need to survive in the market palace.  Take for example IP, one notable aspect of spin-outs is the transfer of intellectual property (IP) from the parent organization to the new entity. Clear agreements about the use of patents, copyrights, and other IP assets are crucial to avoid legal complications in the future. If IP is still owned by the mother company and the spin-out can’t make any changes to that IP it will be extremely difficult for the newly formed entity to adapt to new trends or customer needs.

Criteria for spin-out

The process of creating a spin-out involves several steps, including identifying the spin-out candidate, securing funding and resources, establishing a team of skilled professionals, and last but not least developing the legal structure. However, more important for corporate leaders is to figure out which ventures from the portfolio are right for a spin-out and which ones should be kept within the company.

Thanking the decision of whether a venture should become a spin-out or not is a crucial and oftentimes irreversible decision. Several criteria and considerations can help executives in making an informed choice:

1. Market Potential: Evaluate the market potential of the new idea. Is there a clear demand for the product or service? Is the market of the potential spin-out large enough to sustain a stand alone company, or it will still need to be ‘subsidized’ from the core business? 
2. Strategic Alignment: Consider whether the potential future spin-out aligns with the company’s overall strategy and goals. Will the spin-out contribute to the company’s long-term objectives more if it stays in than if it’s out? Does it fit within the existing product or service portfolio? Will it create more confusion with the existing customer base if kept within the company?
3. Resource Allocation: Assess the resources required to develop and scale the new idea. This includes financial resources, skilled personnel, infrastructure, and time. Determine if the company can provide these resources internally or if it’s more feasible to spin-out the idea.
4. Business Model: Assess whether or not the business model of the potential spin-out can survive outside the mother company or it will die as soon as the ‘umbilical cord’ is severed. Conversely, try to understand if the business model of the potential spin-out venture is too radical for core business and the corporate ‘antibodies’ will sabotage it if kept inside the company.
5. Competitive Advantage: Analyze the competitive landscape. Does the new idea offer a unique selling proposition or a competitive advantage by itself or is it too dependent on the mother ship’s core business for success? 
6. Intellectual Property: Consider the intellectual property associated with the idea. Assess whether the spin-out can own the necessary patents, copyrights, or trademarks to protect the product/service. Clear ownership of IP is essential for a successful spin-out.
7. Entrepreneurial Team: Evaluate the team responsible for the spin-out once it leaves the mother ship. Do they have the entrepreneurial mindset, skills, and experience to run a startup? A capable and motivated team is crucial for the success of a spin-out.
8. Risks and Challenges: Identify potential risks and challenges associated with the new setup. This includes technical challenges, regulatory & legal hurdles, market acceptance risks, and competition. Assess the company’s risk tolerance and ability to mitigate these challenges.
9. Financial Viability: Conduct a thorough financial analysis. Determine the estimated costs of development, market entry, and ongoing operations. Compare this with revenue projections and potential profitability of the case in which the venture becomes a spin-out versus the case in which it remains inside the mother company.
10. Exit Strategy: Consider the long-term exit strategy for the spin-out. Will the company retain ownership, partially divest, or fully sell the spin-out in the future? Evaluate the implications of each scenario on the company’s goals and objectives.
11. Legal and Compliance Issues: Ensure that the spin-out complies with all legal and regulatory requirements. This includes business registrations, licenses, permits, and any industry-specific regulations.

By carefully evaluating the potential spin-out on these criteria, a large company can make an informed decision about whether to pursue the idea as a spin-out or explore other avenues within the organization. 

In the competitive arena of business, spin-outs are the strategic maneuvers that have the potential to drive significant innovation-led growth. However they are complex undertakings that require a delicate balance and a strong due diligence and they are not fitted for every single new idea in a company’s innovation pipeline.