Morphism's R&D Options

An R&D Option conveys the right but not the obligation to acquire an R&D project sometime in the future at a price agreed when the option is created. An R&D option is similar to a consulting agreement that shifts all of the project risk to Morphism. Buying an option allows a client to get research started at low cost. Later, if the client wants, it can exercise the option and acquire the R&D that's been created. Or the client can walk away for any reason at no additional cost.

How they work

In addition to a scope of work and other terms, the basic research option includes a price, a strike price, and an expiration date.

Depending on the situation and terms, the price, the initial payment by the client to Morphism to buy the option, might be as low as zero. Morphism quotes the option price based on various factors. These options typically grant exclusive rights to the client during the option period and subsequently if the option is exercised. Therefore, the client can present the research as an asset (informally speaking) to investors, customers, partners, and others.

When the option expires, the client can acquire rights -- typically all of the rights and on an exclusive basis -- to the research if the client chooses. To exercise the option, the client pays the strike price, in whatever form previously specified, to Morphism on or before the expiration date. Alternatively, if the client doesn't want the research, he just walks away, leaving the research to Morphism. Morphism bears all of the project risk.

How they help

With this financing mechanism, a client can afford to develop and control much more intellectual property. If the company concludes that the research is -- for whatever reason -- not valuable on net to the company, then the company would have spent only a fraction (possibly zero) for what turned out to be a dead end or just irrelevant. If instead the company does want to use the research, then the company benefits from having the research completed while having delayed the expense of developing it. For example, a start-up company might seek an option to expire after a round of financing that wasn't available to fund the research initially, thereby using the initial research to help secure the money that is subsequently used to buy the research.

Q&A

When is an option created?

When you and Morphism agree on the basic terms: the scope of work, the option price, the exercise price, and expiration data, and any other features.
What does an option cost?

Morphism quotes a price based on the other option terms (scope of work, expiration data, exercise price, etc.). The price might be zero. Or more, of course. In every case, the option cost is a fraction of the total expected cost of the project.
What is the "strike price"? "Exercise price"?

Different names for the same thing: what you pay if and only if you want to buy the project.
Can Morphism sell the project to someone else?

Not during the option period, the time between the start of the project and the option's expiration date. If you do not exercise the option prior to the expiration date, then Morphism owns the project exclusively, and Morphism could sell it. That's a typical arrangement, but other provisions are possible.
What about the intellectual property and confidential information I contribute to the project?

A simple option agreement prohibits use of any client confidential information in the project. If you need to contribute anything substantive, then we'd need to work out specific terms to govern your IP.
How long do projects run? How long are option periods?

Projects can be any size. Smaller projects will indicate lower option prices and exercise prices. The expiration date is typically set after the expected end of the project.
What happens if I want to change the scope of work significantly?

Talk to us. Since you can always walk away, you have no additional risk. Depending on the circumstances, we continue with the existing terms or we can negotiate a new agreement. Small changes rarely present a problem, and the option terms motivate Morphism to handle large changes as well.
What if the project takes longer and runs past the expiration date?

The expiration date should be set with a generous margin, but of course delays can occur. Morphism of course performs all typical project management tasks, so you shouldn't be surprised. Depending on the situation, the expiration date can simply be extended.
How are patent applications handled?

Morphism typically has the right to file patent applications before option exercise (if any) at Morphism's sole discretion and expense. If you exercise the option to acquire the research, Morphism (typically) assigns the patent application(s) to you.
How are project expenses handled?

Typically an expense budget is part of the initial scope of work, and that budget is factored into the option price. In that situation, you pay no additional expenses. Of course, other arrangements are possible. Expense sharing is feasible.
Will you do a non-exclusive option?

We can discuss a project you'd like the option to license on a non-exclusive basis. Some open-source-related projects -- and other tasks -- can be appropriate for such an arrangement.

Hypothetical R&D option example

Start-up FooCo Inc. is building a high-performance computer hardware component. For a few applications, real break-through performance might require some custom application software libraries that are tailored to the component. FooCo is considering whether to invest in the development of a specialized library.

Background

FooCo is primarily a hardware company, and it has limited financing -- of course. FooCo has closed an angel round, and it's seeking Series A money. The company is considering entering the market with the hardware and core device drivers, leaving the custom libraries for later consideration. Management is conflicted about this approach, but the company simply can't spend much money on a project that it might not need and might not even work.

What do to?

During its pitches for Series A money, prospective investors and FooCo's management discuss the issue. FooCo explains some of the benefits, costs, and risks of developing the libraries. To pursue the application-level opportunities, FooCo would need different skills. Time and money would have to be allocated to the effort, and both are scare. No one wants to be distracted from the primary mission. However, the risk of missing potentially key intellectual property and a richer solution is troubling.

Buying the option

To cover those bases, FooCo goes to Morphism for an option on the software library project. After Morphism's review of the scope and other issues, Morphism and FooCo work out the details. With the option secured and work underway, FooCo reports its broader, cost-effective capability to potential investors and customers. Naturally FooCo completes its Series A round.

Time passes, and FooCo's R&D option is set to expire.

Exercise the option?

Scenario 1: FooCo doesn't want the research

In this scenario, the research results were very good. However, FooCo's product revenue is growing nicely, and it makes more sense to invest its modest resources in that offering alone. FooCo doesn't exercise the option, allowing FooCo to continue to invest with focus.

Equivalently for FooCo, the research resulted in performance improvements insufficient to justify exercising the option, so FooCo walks away from the research, glad it didn't spend lots of its own money only to come to that conclusion.

Scenario 2: FooCo does want the research

FooCo decides to exercise the option to acquire the research because the product alone isn't providing sufficient value. Or because customers perceive a gap that the research could fill. Or, worse, because the product has failed, and FooCo is looking to license the intellectual property it did generate. In this case, FooCo might determine it can make more money by licensing the research along with its internal research. Maybe what appeared to be tangential turns out to be very valuable. (FooCo of course calls Morphism to help with licensing to third parties.)

Alternately FooCo's product is doing very well, and the associated cash flow and Series B investment allows FooCo to expand its offerings. The research is complete and ready for productization (or perhaps even sale). FooCo now has a competitive advantage in a key market due to the research it financed early and paid for with Series B money.

Commentary

During the Series A pitches, an investor asked about this research option. If FooCo declines to exercise the option, what happens to the research? Could FooCo get sued over that stuff? Fortunately FooCo reported that its option included a provision giving FooCo fairly broad (but non-exclusive) rights to the technology in the event that the option isn't exercised. So FooCo is covered.

Another prospective investor asked about the intellectual property that FooCo would provide to Morphism to conduct the research. FooCo reported that the option expiration was set so that the only confidential information provided to Morphism would become public (say via product specifications) before the option expired. FooCo understood that the definition of the scope of the research was appropriate for more of a build-to-spec arrangement than a joint development effort.