Spinning Out a Star

by Michael D. Lord, Stanley W. Mandel, and Jeffrey D. Wager

Reprint r0206h

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 June 2002

HBR Case Study r0206a

The Skeleton in the Corporate Closet
Julia Kirby

HBR at Large r0206b

My Week as a Room-Service
Waiter at the Ritz
Paul Hemp

Managing Yourself r0206c

A Survival Guide for Leaders
Ronald A. Heifetz and Marty Linsky

Charting Your Company’s Future r0206d

W. Chan Kim and Renée Mauborgne

The Very Real Dangers r0206e

of Executive Coaching
Steven Berglas

Value Acceleration: Lessons r0206f

from Private-Equity Masters
Paul Rogers, Tom Holland, and Dan Haas

The People Who Make r0206g

Organizations Go – or Stop
Rob Cross and Laurence Prusak

Best Practice r0206h

Spinning Out a Star
Michael D. Lord, Stanley W. Mandel,
and Jeffrey D. Wager

Frontiers r0206j
Have Your Objects Call My Objects
Glover T. Ferguson

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Most spinouts flop. But Targacept
flourished when its parent set it loose.
Here’s how it beat the odds.
Spinning Out a Star
by Michael D. Lord, Stanley W. Mandel,
and Jeffrey D. Wager
H
ow many promising R&D proj-
ects are going nowhere at your
company? Ten? Fifty? One hun-
dred? Many organizations sit on a pleth-
ora of potentially valuable ventures that
languish because they don’t quite fit
into current strategies or operations.
And when times get tough, these non-
core projects become obvious candi-
dates for divestiture. By packaging them
as stand-alone entities and spinning
them out, companies can quickly tone
up their finances while creating the po-
tential for a cash windfall should the new
business one day go public.
That’s the theory anyway. In reality,
though, spinouts rarely take off. Among
the 50 or so we have studied in depth
over the past seven years, two-thirds ei-
ther fell short of expectations or failed
outright. Some were ill conceived from
the outset, having little or no market
potential. Some lacked the right leader-
ship and management teams. Some
were cut off from their parent compa-
nies before they could develop the re-
sources they needed to survive. And
some were held too tightly by their par-
ents, never getting the room to breathe
Copyright © 2002 by Harvard Business School Publishing Corporation. All rights reserved.
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March 2017.
Best Practice
on their own. Whatever the reasons,
companies that go to the trouble of spin-
ning out a business usually end up with
little to show for the effort.
But there are exceptions. In the life
sciences, for example, the record is
much better. R.J. Reynolds, the tobacco
giant, recently spun out a pharmaceu-
tical business called Targacept that is
now well on its way to success as a sep-
arate company. Targacept’s story shows
that nurturing a successful spinout is
not all that different from raising a
healthy, independent child. Parent com-
panies need to give their offspring the
right amount of attention and care, but
they also need to know how and when
to set them loose. Learn to do that well,
as RJR and Targacept discovered, and
both the parent and the young com-
pany stand to reap handsome rewards.
The Four Spinout Traps
Before looking closely at Targacept,
let’s consider why so many spinouts
flounder. The general reason is simple:
The parent company does not provide
the critical strategic, organizational,
financial, and legal foundations the
5
 B E S T P R A C T I C E • S p i n n i n g O u t a S ta r
young company needs to survive and
thrive on its own. More specifically,
we’ve found that most spinouts fall into
one or more of four traps that doom
them from the start.
The Crown Jewel Trap. Some com-
panies spin out ventures that simply
are too close to the core of their main
businesses. In effect, they sell their
crown jewels. This was the case with
Staples.com–one of many on-line retail
ventures born of the dot-com frenzy.
Late in the process of spinning out
Staples.com, Staples’ executives realized
that an on-line channel would have to
be an integral part of the company’s
business going forward, and they put
on the brakes. But even though Staples
came to its senses in time, it paid a
price for its misadventure: Sharehold-
ers revolted as the parent tried to buy
back Staples.com executives’ pre-IPO
shares at what were viewed as vastly
inflated prices.
The Piggy Bank Trap. Sometimes a
parent company is more concerned
about quarterly earnings or other short-
term financial exigencies than about
sound strategic reasons for a spinout.
It uses the spinout primarily to pawn off
debt or expenses or to quickly raise ex-
ternal capital for itself. This is an easy
trap to fall into, and one that is ex-
tremely tempting; after all, the capital
requirements of funding a new venture
can be large, the risk is substantial, and
the payoff may be relatively distant. But
as the story of Enron’s off-balance-sheet
partnerships makes appallingly clear,
this kind of myopic financial gimmickry
creates more problems than it solves –
especially if it’s used merely to delay or
avoid the pain and responsibility of
making tough investment choices.
The One-Legged Stool Trap. A com-
pany may try to spin out an area of its
business that lacks one or more of the
critical legs of a successful company –
a coherent business model, say, or a solid
financial base. Consider some of the in-
famous retail spinouts of the late 1990s,
such as Walmart.com or Kmart’s Blue-
Light.com. Quickly slapped together
during the Internet-retailing frenzy,
these ill-formed business models could
6 harvard business review
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not support their own marketing, oper-
ations, finance, human resources, distri-
bution, and fulfillment efforts. Both
Walmart.com and BlueLight.com were
spun back into their parent organiza-
tions less than 18 months after being
spun out, wasting millions of dollars.
A single channel or patent rarely makes
a successful spinout; it simply lacks the
legs to stand on its own.
The Umbilical Cord Trap. In many
cases, parent companies are too tenta-
tive. They can’t bring themselves to
sever their ownership ties and give up
control of their spinouts. Sometimes,
the parents fear they’ll lose out on some
of the potential long-term financial
gain. Other times, parent executives just
can’t turn the reins over to new leaders.
Eventually, though, continuing entan-
glements with the parent interfere with
the spinout’s ability to make smart
strategic and financial decisions. What’s
more, the close ties can spook key out-
side stakeholders, particularly poten-
tial partners and investors. See the side-
bar,“Thermo Electron: Spinning Out of
Control,” for an extreme case of such
complex entanglements.
The Origins of Targacept
RJR avoided all of these traps when it
set up Targacept as a stand-alone busi-
ness. To see how requires a little history.
Targacept grew out of RJR’s extensive
research into the pharmacology, chem-
istry, and toxicology of nicotine. Be-
tween 1987 and 1995, RJR devoted tens
of millions of dollars to what it called
its Nicotine Research and Analogue
Development Program (NRADP), an
effort to better understand tobacco-
related safety and product issues. The
program encompassed a world-class
research center and more than two
dozen scientists. Serendipitously, much
of the research they conducted and the
compounds they discovered appeared
to have potential therapeutic applica-
tions for a wide variety of ailments,
including Alzheimer’s and Parkinson’s
diseases, ulcerative colitis, and Tourette’s
syndrome.
But by the mid-1990s, pressure on the
tobacco industry was intensifying, and
March 2017.
RJR’s parent company, RJR Nabisco
Holdings, was in the midst of a corpo-
rate breakup. RJR Tobacco was forced
to retrench and focus on defending its
core business; its top managers could
no longer afford to lavish time and re-
sources on one of the company’s more-
promising, if surprising, areas of new
product development. As one of the
NRADP researchers puts it: “RJR’s core
product is an agricultural product that
comes rolled in paper; it’s manufactured
very simply. An R&D-intensive phar-
maceutical business was hardly a stra-
tegic fit.” Internal interest in NRADP
evaporated, its funding dried up, and de-
spite its promising discoveries, its future
within RJR looked bleak.
Some of RJR’s executives wanted to
drop the research program altogether.
Others felt content to let it limp along
with minimal support. Still others ar-
gued that RJR should try to sell off or
license NRADP’s intellectual property to
recoup at least some of the company’s
investment. But when RJR formally re-
viewed its options during 1996, with the
help of the consulting firm Common-
wealth Pharmaceutical Partners, it saw
that NRADP had considerable com-
mercial potential. Its assets, after all,
were not limited to a single patent or
idea but encompassed many patents,
a crew of talented researchers, and a
range of distinctive capabilities and
technologies. With the right support,
RJR concluded, NRADP could flourish
as an independent company.
But the path to independence would
not be easy. NRADP, after all, was just
a loose gaggle of researchers with a nice
lab. It needed to become an autono-
mous, well-oiled operating company,
and it needed to do that without drain-
ing too much additional cash from RJR’s
Michael D. Lord is an assistant professor
of strategy and international business,
and Stanley W. Mandel is the executive
professor and director of the Angell Center
for Entrepreneurship, both at Wake Forest
University in Winston-Salem, North Car-
olina. Jeffrey D. Wager is a managing
member of CPP Advisors in Framingham,
Massachusetts.
 S p i n n i n g O u t a S ta r • B E S T P R A C T I C E

coffers. Achieving independence – stra-
tegic, organizational, financial, and le-
gal – required four things: strong lead-
ership, a clear identity, solid alliances,
and a set of willing investors.
Balanced Leadership
The first hurdle the venture had to clear
was getting the right leadership to
champion the cause. To increase the
odds of success, we’ve come to believe
that a spinout candidate requires an
“inside outsider” at the helm: an enthu-
siastic advocate who has credibility and
clout within the parent company but
who will fight for the spinout’s right to
exist independently. The leader also has
to be a skilled negotiator–someone who
can balance the needs of the infant com-
pany with those of its parent and its fu-
ture partners and investors.
J. Donald deBethizy embodied those
qualities. As an RJR vice president of
R&D–and a former NRADP researcher
himself – he was both a respected sci-
entist and an experienced R&D man-
ager. He passionately believed that
NRADP’s discoveries could alleviate
human suffering. By 1996, deBethizy
had volunteered himself to be NRADP’s
active champion, even as he continued
to hold his full-time job as head of
RJR’s overall product R&D efforts. In
order to simultaneously manage his
165-person division and plan and im-
plement the spinout, he recalls, “I had
to start balancing a lot of different,
competing demands. I started delegat-
ing the RJR work like crazy.” Juggling
disparate responsibilities and loyalties
is a critical part of the spinout leader-
ship process.

Thermo Electron: Spinning Out of Control

The story of Thermo Electron illustrates the dynamics
and difficulties of the umbilical cord trap. Founder George
Hatsopoulos was one of the great company builders
of the past century. Starting in 1956 with $50,000, he built
the business into one of the world’s leading instrument
and measurement companies. Until the early 1990s, the
company quietly went about building its business, adding
new technologies and divisions to its corporate portfolio.
In the mid-1980s, however, Hatsopoulos had begun to ex-
periment with a novel strategy. Frustrated by the need
for more capital to build Thermo’s technology-intensive
businesses and intent on fostering the same sort of en-
trepreneurial spirit among his executives that drove him
to found the company in the first place, Hatsopoulos
began to spin out various divisions as quasi-independent
companies – most with their own publicly traded shares
but with Thermo Electron as the primary stakeholder.
The logic was simple but compelling: Thermo Electron
would be able to raise independent capital for each
spinout. IPOs would fund these promising but risky and
capital-intensive new technology ventures; if there were
gains, Thermo Electron, as the majority shareholder,
would reap them. At the same time, managers of the
new spinout subsidiaries would enjoy an entrepreneurial
freedom and a share in their own units’ success that was
previously unavailable to them. That would allow Thermo
to better attract, retain, and motivate top talent.
The combined value proposition appealed to investors.
They saw the opportunity to buy stakes in entrepreneurial
businesses whose strategic and financial potential
wouldn’t get buried within the complexity and bureaucracy
of the corporate parent. The market richly rewarded both
Thermo Electron and its spinouts, tripling the parent
company’s market value between 1993 and 1996. Thermo
became not only a Wall Street darling but also the focus
of numerous glowing case studies and articles in both
management and finance publications.
By 1998, however, Thermo found itself at the center
of a confusing constellation of two dozen partially spun
out subsidiaries. Since each had its own board, the entire
Thermo confederation generated more than 100 board
meetings per year. Managers complained that Thermo
had become a series of fiefdoms and that it was often
more difficult to do business with a fellow Thermo
spinout than it was with a competitor. Since many
of the business functions among the various spinouts
overlapped, customers and investors were confused.
The incoming president, Marijn Dekkers, admitted that
he didn’t know exactly what kind of company Thermo
Electron was until he was offered the job, even though
he had been doing business with a number of far-flung
Thermo spinouts for years.
Many of the spinouts languished after their IPOs;
the companies were too small and their stocks too thinly
traded to attract enough attention. Moreover, investors
began to question the confusing and tangled web of
financial ties between Thermo and its many spinouts.
When Thermo reported negative results for one of its
major spinouts in early 1998, the parent’s share price
began a long, hard slide, plummeting from almost
$40 per share to nearly $10 and staying there. Clearly,
the gloss was off Thermo’s previously much-celebrated
spinout strategy.
By 2000, Thermo Electron’s founders retired and
a new management team, led by Richard Syron, was
installed. Conceding that many of the parent company’s
spinouts were in fact core businesses that needed to be
brought back under the corporate umbrella, the new
team announced a sweeping reorganization and initiated
plans to buy back most of the spun out subsidiaries. A
few noncore, partially spun out assets were to be wholly
divested. By the end of 2001, Thermo had undone
virtually all of its spinouts, completely reversing its
earlier partial-spinout strategy.

june 2002 7

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 B E S T P R A C T I C E • S p i n n i n g O u t a S ta r
RJR Tobacco’s CEO, Andrew Schind-
ler, knew deBethizy to be a capable
R&D executive. But privately he won-
dered whether someone accustomed
to big corporate budgets and long time
frames could adapt to the pace of an en-
trepreneurial venture. RJR could have
followed the example of many parent
companies by installing a hired-gun ex-
ecutive with more start-up experience
to run the spinout. But despite his mis-
givings, Schindler decided to give the
first-time entrepreneur a chance, trust-
ing to deBethizy’s passion and his strong
management skills. Besides, to hire and
bring an outsider up to speed at this
point would cause too many delays and
disruptions.
Early in the spinout process, deBethizy
helped prove he was up to the job when
he negotiated a life-support deal with
Schindler. Operating funds for NRADP
had nearly dried up, and many top
managers within RJR were continu-
ing to lobby to shut the group down.
DeBethizy walked into Schindler’s office
to ask for more time. “I already knew
that Andy would not give us another
dime,” he recalls. “He said ‘Get out!’
and threw me out of his office. But I
knew Andy well enough to know that
he changes his mind.” DeBethizy kept
at Schindler and convinced him of the
spinout’s feasibility. The two men worked
out a compromise: NRADP could con-
tinue to operate on the barest of sup-
port from RJR. But if the spinout could
not fully finance itself by the end of
1998, it would be shut down.
Schindler could have been more gen-
erous, but he believed that it was in the
fledgling business’s best interest to be
under financial pressure. “By threaten-
ing to shut it down, I was trying to spur
it to the next step,” Schindler explains.
“This is the kind of pressure that a new
venture needs to succeed.” Without the
assurance of internal funding, deBethizy
and his team would have to work all the
harder to gather outside investment.
Some companies make the mistake, like
many rich parents, of merely giving their
spinout children money when what they
need to foster is discipline–the same dis-
ciplines successful start-ups employ –
8 harvard business review
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to learn to make it on their own. It was
the formal disciplines of company build-
ing that deBethizy turned to next.
A Company Takes Shape
In January 1997, deBethizy was at the
helm of an internal research organiza-
tion in the tobacco industry that held
dozens of patents relating to human
and animal health. To turn those assets
into a viable company in an entirely
different industry, he essentially needed
to start from scratch. As if for a start-up,
he needed to establish a strategic plan
It’s one thing for the parent company to have
confidence in the venture, but what if it’s deluding itself
into thinking there’s more there than there really is?
that identified what the new venture
would produce, who its customers would
be, how it would turn a profit, and how
it would relate to both partners and
competitors in the pharmaceutical in-
dustry. In this regard, RJR was lucky –
the spinout was so far afield from its
normal business that it was clear the
new venture would need to go through
some basic strategic-planning exercises.
But this strategy-making process is criti-
cal for any spinout so as to set clear goals
and boundaries – and particularly so it
can avoid all-too-common future con-
flicts (turf battles, for instance) with the
parent company.
DeBethizy, along with the consul-
tants and other principals from NRADP,
sifted through dozens of ideas and de-
cided to focus NRADP’s work on devel-
oping specific therapies for disorders
affecting the brain and central nervous
system. Then they developed a succinct
business plan to present to prospec-
tive partners and investors. Arising out
of what had been for 15 years a quasi-
academic R&D lab, this new and co-
herent business focus was a seminal
achievement.
Even so, deBethizy soon discovered
that developing the plan was much sim-
pler than developing an organization.
Here, the challenge was to disentangle
the child from the parent, a problem
March 2017.
start-ups clearly do not have, and one
that needed all of deBethizy’s inside-
outsider savvy.
When Schindler recommended that
an RJR business development expert
be brought in to build some organiza-
tional order into the R&D group, the
result was divisiveness. The expert rec-
ommended removal of a key scientist
on the grounds that he had little busi-
ness experience. The suggestion raised
the hackles of both the scientist and
other group members, and deBethizy
had to step in to smooth things out.
“I learned that you can’t delegate orga-
nizational development of a fragile group
to an outside manager,” deBethizy says.
“Indeed, in the beginning, you can’t del-
egate it at all.”
While repairing relations with the sci-
entists, deBethizy established close ties
to legal and financial players who could
help separate his group from the parent
company. He formed a key relationship
with an RJR attorney whose job it was
to assign and protect NRADP’s intellec-
tual property even as RJR’s core business
was becoming the subject of an FDA
investigation. The attorney helped seg-
regate NRADP’s therapeutic research
from research involving consumer to-
bacco products, allowing the group to
keep its discoveries to itself. RJR avoided
a potential umbilical cord trap by as-
tutely assigning all of NRADP’s intel-
lectual property to the new company.
The assurance of no strings attached
would later put the venture on a level
playing field with, and reassure, outside
partners and investors.
DeBethizy also cultivated a close
working relationship with a skilled
accountant and controller within RJR
enlisted to help with the spinout. In
order to establish the unit as an inde-
pendent subsidiary, the accountant
separated the new company’s account-
ing and payroll systems from those of

the parent and developed independent search and development staff, the group
audited financial statements; she also leased space within RJR’s R&D build-
set up new benefit programs and 401(k) ing at a fair market rate.
systems for the 12 researchers and ten It was during this process that
contractors in the spinout group. The deBethizy and his team began think-
separation from RJR was also literal: ing about a corporate name and sym-
Sequestered from the rest of RJR’s re- bol. The result of their brainstorming
Birth of a Spinout
Stage Key Challenge Critical Considerations
Conception The decision: Is a spinout really the right strategic
why and when to choice? Or should we develop internally,
spin out (or not) form partnerships, license, sell, or simply
cut the program? What’s the best way to
maximize value creation?
Gestation The team: Who will lead and champion the nascent
leadership and venture? Should the leader come from
championing outside or inside the corporate parent?
Which key managerial and technical
people should go with the spinout and
which should stay with the parent?
The strategy: What will be the specific strategic scope
focus and purpose and direction of the spinout? What are its
vision, mission, goals, and objectives, espe-
cially vis-à-vis the parent?
The organization: Is it necessary to create internal legal,
creating internal financial, and organizational autonomy
autonomy for the spinout as a prelude to its eventual
separation from the parent and, if so, how?
Separation Alliances: Who should we pursue as partners?
attracting and How can we convince them to join?
negotiating with How can the parent and spinout best
outside partners tackle the three-way negotiations?
Funding: Who should we pursue as investors?
attracting and How much should we sell and at what
negotiating with price? Again, how can the parent and
outside investors spinout best tackle the three-way
negotiations?
Freedom: What should be the nature of the relation-
achieving true ship between parent and offspring? How
independence can the spinout be free to chart its own
course while still allowing the parent to
recoup its investment?
june 2002
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S p i n n i n g O u t a S ta r • B E S T P R A C T I C E
was Targacept, stemming from the R&D
focus on targeting nerve receptors.“The
defining and naming of the company
was powerful because it created an
identity for everyone to rally around,”
deBethizy later observed. In February
1997, Targacept became a wholly owned
Recommendations
Make sure the spinout has a sound strategic
logic behind it. Ensure that it is not driven
by short-term financial gimmicks and that
it is indeed a noncore asset with a solid
case as a stand-alone business.
Initially, a leader from the ranks of the
parent company may be best able to
navigate the process; later, increased
external leadership likely will be required
or negotiated, especially as the spinout’s
independence grows.
The spinout should have a clear under-
standing of what it is and what it will
do. Reduce future tensions and conflicts
with the parent by defining its focus and
boundaries up front.
Create a legally separate subsidiary
or affiliate with its own management,
organization, and books. Minimize
complex parent-offspring ties.
Gather outside partners to validate
and accelerate the separation process.
Remember that spinout partners don’t
want to be entangled in complex or
subordinate relationships with the parent.
As with partners, outside investors should
be brought in to validate the merits of the
venture and to accelerate the separation
process. But investors need to know that
they’re on a clear and level playing field
when investing in the spinout, not one
skewed by entanglements with the parent.
The parent should drop to a minority stake
and should not dominate the spinout’s
management or board. Any remaining
umbilical ties should probably be severed
so that dealings between the parent and
the spinout stay at arm’s length.
9
 B E S T P R A C T I C E • S p i n n i n g O u t a S ta r
subsidiary of RJR, with its own employ-
ees, assets, and financial statements, and
the next month deBethizy was formally
named president of the company.
A Last-Second Alliance
One of Targacept’s first challenges as a
separate (but still wholly owned) sub-
sidiary of RJR was to find a partner that
could provide additional, outside fund-
ing, as well as the experience and credi-
bility it needed to survive in the phar-
maceutical business. DeBethizy began
knocking on the doors of large pharma-
ceutical companies in search of an R&D
partnership. He and his team hoped
that by exchanging some of Targacept’s
research, they would be able to form
an alliance with “Big Pharma” to serve
as a solid entrée into the industry and,
eventually, to help secure the infrastruc-
ture – manufacturing, sales, support,
global reach, brand recognition, and so
on – that the new venture lacked.
By early 1998, Targacept entered into
negotiations with one large U.S.-based
drugmaker, and a rewarding partner-
ship looked imminent. But when senior
executives at the pharmaceutical com-
pany realized that Targacept belonged to
a tobacco company, they grew skittish,
and the negotiations quietly cooled. In
April, the deal was nixed. The lesson was
bitter, but important: Outside stake-
holders, including key partners, wanted
to deal with the spinout on its own
terms, free of the parent’s shadow. This
problem was perhaps especially poi-
gnant in RJR’s case, but it is not at all a
unique dilemma. Lingering ties between
a parent and its spinout often create
uncertainty and risk that can spook po-
tential partners.
In the wake of this disappointment,
deBethizy approached Schindler to ask
for more money, but RJR’s CEO re-
mained firm: Secure a partnership and
funding deal by the end of the year,
he told deBethizy, or face shutdown.
DeBethizy and his team began calling
on foreign pharmaceutical companies
less ruffled by Targacept’s corporate par-
entage. By the fall of 1998, with only a
few months left to survive, Targacept
found itself courted by three global
10
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drug companies. But its happiness was
short-lived; within a matter of weeks,
two of the three corporations became
embroiled in mergers, and their inter-
est in striking a deal with the little
company waned. Fortunately, the third
prospective partner – the French giant
Rhône-Poulenc Rorer (today Aventis) –
remained interested.
Negotiations continued – literally – to
the 11th hour. At 11 pm on December 30,
1998 – the final day before RJR planned
to shut the group down – Targacept
inked a multimillion-dollar deal with
Rhône-Poulenc to explore therapies for
Parkinson’s and Alzheimer’s diseases.
In negotiating with Rhône-Poulenc,
deBethizy and his team found them-
selves playing poker. “We had to pre-
tend that competition for the deal with
us was still very active,” deBethizy re-
calls.“You just cannot crack. You have to
keep telling yourself they will be lucky
to get you.” At the same time, he recog-
nized that any show of greed might
threaten the relationship; some conces-
sion was in order. When Rhône-Poulenc’s
lawyers voiced concern that Targacept
might want to gain access to a portion of
the larger company’s intellectual prop-
erty, deBethizy’s group signed a warrant
declining its interest in such access.
The partnership bought the new com-
pany enough time and money to de-
velop more research and pursue ven-
ture investors. The association with
Rhône-Poulenc also helped build a case
to both RJR and the outside world that
Targacept was a company with real
potential. Such outside validation is
important to any spinout, no matter
how familiar the parent might be with
the spinout’s business: It’s one thing
for the parent company to have confi-
dence in the venture, but what if it’s de-
luding itself into thinking there’s more
there than there really is? Outside vali-
dation by an outside partner willing to
commit itself in a substantial way is crit-
ical to confirming commercial viability.
Prospecting for Cash
Gaining the confidence of outside in-
vestors is another critical step toward
establishing a spinout as a credible,
March 2017.
independent business venture with real
potential. Some of the key financial
questions for a spinout are inherent to
any new start-up, but others are par-
ticular to a spinout’s unique situation.
Targacept discovered a large number of
potential investors who were interested,
for example, but some were wary of get-
ting involved with RJR as a majority
owner. Few savvy investors are likely to
participate in a venture in which they
know that their interests, and their in-
vestments, might be subordinate to the
whims of a lingering corporate parent. In
some of the early discussions, deBethizy
confronted one cigar-chomping investor
who exclaimed: “I am going to cut to
the bottom of this: We have got to cut
RJR below 50%. I am not going into a
company where RJR has a majority of
the shares.” The investor also didn’t hide
his opinion that Targacept would not
have a prayer of garnering investment
as long as deBethizy – who was, after
all, a tobacco-industry executive – was
in charge.
DeBethizy had to make a better case
to investors about why he was the right
person to run the new venture, and RJR
had to decide whether to give up control
of its progeny. For his part, deBethizy
negotiated a compromise with invest-
ors: He would be CEO, but the board
would keep a close watch on Targacept’s
initial postindependence trials and tri-
umphs. Meanwhile, realizing that RJR
was likely to be better off owning a
smaller piece of a successful spinout
than a large piece of a new venture with
inadequate outside support, Schindler
agreed to lower RJR’s stake to a minor-
ity position.
With that assurance, half a dozen out-
side investors signed on. Further ce-
menting Targacept’s independence after
the venture investors were brought on
board, RJR retained only two of seven
positions on Targacept’s board of direc-
tors; five were outsiders with deep ties
to the biotechnology, pharmaceutical,
and investor communities. While the
need to scale back RJR’s stake may have
been all the more apparent in Targa-
cept’s case, the lesson can be applied
more generally. A spinout that is ma-
harvard business review

jority owned by a parent is not really a
spinout; it is just a subsidiary in disguise.
It is usually in everyone’s best interests
to reduce parent ownership to a minor-
ity stake.
That was certainly true for Targacept.
By the summer of 2000, Targacept had
raised $30.4 million, an extraordinarily
large amount for a first round of venture
capital funding in the biotechnology or
pharmaceutical industries. It was, in
fact, at the time the fourth-largest first-
round venture financing in U.S. biotech
history. Armed with the cash, Targacept
was now ready to stand on its own. On
August 22, its spinout from RJR was
completed, and it became the fully in-
dependent Targacept Incorporated.
Today, Targacept is valued at approx-
june 2002
This document is authorized for use only in Julio Pertuze's 2016 Laboratorio de Innovaci?n (Trim 3Q) course at Pontificia Universidad Catolica Chile (PUC-Chile), from September 2016 to
S p i n n i n g O u t a S ta r • B E S T P R A C T I C E
imately $100 million. It has a number
of drugs in development; the first could
go on the market as early as 2005. And
Targacept’s parent could hardly be more
pleased. Not only has R.J. Reynolds re-
covered the cost of its investment in
NRADP, but its stake is currently valued
at more than $40 million, with the pos-
sibility of even greater returns from Tar-
gacept’s future IPO. Schindler’s final
assessment? “We’re very happy with Tar-
gacept. I think spinning it out was the
right thing to do, and this was the right
way to do it.”
As an example, Targacept shows why
it can make great strategic and financial
sense to spin out new ventures – but it
also shows why executing a spinout is
far from easy. The problem with spin-
March 2017.
outs is the same as the problem of rais-
ing a healthy family: Parents need to
nurture their progeny, providing them
with the right foundation. But they also
need to know when and how to let go
and allow them to stand on their own.
Once a spinout is set free, of course,
there is certainly no guarantee of suc-
cess. As with any new company, it’s free
to flourish or fail on its own. But with
the right kind of nurturing, the spinout
can begin its independence healthy and
strong. And that’s at least a very promis-
ing start.
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