What About Success?

What will you do with all that money?

Congratulations you’ve successfully commercialized a blockbuster+ product. The firm writes you a check for one billion U.S. dollars (illustratively). You’ll not be putting this money into a certificate of deposit.

The firm, typically as majority owner of the research unit, gets a predominant say in how the money is apportioned. The research unit (the legal entity) will likely be mandated to buy back, as treasury shares, some of the shares owned by the firm in the research unit. These are purchased at market price and can cost more than half of the blockbuster windfall+.1

The firm had an outlay approaching U.S. $500 million to get you to your first blockbuster and would like the cash back (it received interest payments along the way for the ‘loan’). Consider this buy-back of shares by the research unit as a balloon payment on a loan. It does reduce the firm’s ownership in the research unit, but not yet below a controlling interest.

The firm recognizes you’ll need many hundreds of millions of dollars to fund research for the next blockbuster pursuit. You need to invest the proceeds of your first blockbuster, and the firm will likely insist you invest it into other research units (or into the firm itself). You want a short term, low-risk investment since you intend to sell these shares to fund research in the coming years, so you’ll look to invest into a basket of franchise-member shares. Research unit shares are fungible, in that they are either publicly traded or the firm maintains a robust internal market. The firm, as market-maker for this basket of shares, ensures that your windfall from the first blockbuster sale is productively employed in blockbuster pursuits by other research units, that you have access to the money when you need it, and that the basket of shares is structured in a way (e.g., by maturity) to minimize volatility in share price.

Management of the research unit wants to know when they’ll gain a full controlling interest in their own firm. How do research units reduce the parent firm’s ownership to a point where the firm no longer has a controlling interest? By finding the second blockbuster. The firm paid for the first blockbuster and so retains ownership in the research unit. The research unit pays the costs (in essence) for the second blockbuster and so employees gain a controlling interest in their firm as a result. That’s the way the math works out. Employees of the research unit (legal entity) are already close to owning a controlling interest after the first blockbuster. It’s no stretch for them to purchase a controlling interest after the second.

The above scenario assumes everything goes well. The research unit was successful in commercializing its first blockbuster product and still has potential for more blockbuster products. Based on their first success they have full funding lined up for the second blockbuster pursuit. They have practical experience in commercialization+. They have a scientific competitive advantage in their technology platform. They have invested (indirectly) into other research units. Management and employees of the research unit are now close to operating like a fully-integrated research and commercialization firm.

What if things don’t go quite so well? Suppose we write a check for one billion U.S. dollars to a research unit with no further blockbuster potential? The research unit legal entity is dissolved and the funds are distributed to shareholders just like in any other corporate shutdown. Should research unit management decide to continue, specializing in sub blockbuster+ products for example, then this happens within a new legal structure. Consistent with our theme of ‘ending well’, the firm helps get them on their feet during an orderly transition+ period. The firm retains ownership in the Intellectual Property developed under the original franchise agreement, as an insurance policy, to protect against ‘hidden’ or ‘missed’ blockbuster products.

The firm prefers successful research units to stay on as members of the franchise program as long as they have blockbuster potential. This is one of our measures of success for the franchise program. Successful research units bring both the experience and the cachet desired within the membership+ ranks. These research units continue as the same legal entity with the same membership rights and responsibilities. The only change is they are now majority-owned by research unit employees. After two major successes it’s not a stretch for us to imagine the research unit retaining its membership: it’s worked well for them thus far.

Home Page October 2010

  • 1. Market Capitalization for the firm will likely be 10-15 times earnings, which means the research unit can be worth U.S. $5-10 billion.