Editor’s Note: San Francisco-based Murray Indick is a partner at global law firm Morrison & Foerster where he co-chairs the firm’s emerging company and venture capital practice, and Connor Acle is a summer associate with the firm. Morrison & Foerster assists companies and their investors at every stage of the business lifecycle, from initial formation and financings, through late-stage financings and investments, mergers and acquisitions, and public offerings. Here they offer legal insights on how to launch an agtech startup.
Agtech startups face unique challenges in their initial formation and financing. Below are some suggested best practices for launching a new agtech startup in the United States in 2017, given the current general environment for emerging businesses.
1.“Plain vanilla” formation documentation. To state the obvious, it is hard work to form, finance, and grow a durable business. We think startups generally should use simple, clear documents in their corporate formation that have previously been approved in the marketplace; wrinkles at the formation stage typically raise red flags for investors. For those agtech startups that expect to raise venture capital funding in the future, the default is to form a corporation in Delaware and to have a standard “starter kit” of key form documents.
2. Develop an intellectual property strategy immediately. Agtech startups often rely on proprietary innovations to anchor the company. Without proper legal protection, these technologies can be appropriated by competitors or even employees. To avoid this, and as is the case with startup businesses generally, all employees and advisors should sign an IP assignment agreement and related documentation to ensure that the work will be owned by the company, rather than the individual, subject to requirements of law.
California law, for example, provides that inventions made by an employee without company resources, offsite, off hours, and unrelated to the company’s business, cannot be covered by an IP assignment agreement.
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In addition to this now-routine protection, agtech founders must devise and implement a strategy to best protect their creations from other businesses. Unlike in other tech startups, where a patent prosecution analysis and strategy is relatively straightforward, agtech startups typically require a greater level of customization. A patent strategy (limited to the United States or expanded globally) may make sense, but it is equally likely that founders will rely exclusively on a trade secret strategy. Founders always struggle with limited available cash and the need to prioritize; in our experience, the counterparties for agtech startups are frequently large corporate entities, and the IP strategy must take this reality into account. Trademarks generally have the same level of prioritization for agtech startups as they do for other startup businesses, and founders typically focus on whether to mark names and logos and acquire full access to all URLs.
3. Focus on counterparties, recognizing delays to closure. Agtech startups, unlike many other emerging businesses, often seek to partner with government agencies, universities, or other third-party researchers to develop their technology. These partnerships and licenses require clearly delineated rights and obligations, and short, “plain vanilla” agreements, are not likely to exist. The experienced entrepreneur recognizes this is part of the cost of doing business in the agtech space and budgets accordingly for legal review and negotiation.
We also counsel patience. In this vertical, it simply takes time to negotiate a fair term sheet even for early-stage funding and, thereafter, to have full diligence completed and documents drafted, negotiated, and executed. By contrast, “hot” tech startups often close immediately following investor days on standard SAFE or convertible note documentation, with very abbreviated diligence, because funders may be high-net-worth individuals and venture capital firms that immediately grasp the disruptive concept. In the agtech world, by contrast, founders need to anticipate the nature of the counterparty (including bureaucracy). Many technology transfer groups at major universities have developed standard forms for license and other commercial agreements, and agtech startups need to proceed with great care on economic and other issues. The important related point is that future investors in an agtech startup business will retain their own counsel and scrutinize these agreements in their diligence before investing, and they will walk away from consummating an investment if the agtech startup has given away too much.
4. Assess the latest investor landscape. The agtech startup world is currently developing at a rapid pace, with new market entrants. There are a handful of traditional venture capital funds that have recently invested in agtech startups. Corporate investors are also moving into the space, and it has been reported that in 2016 corporate investors participated in about one-quarter of all agtech financings. As large capital deployment opportunities are presented, we would expect sovereign wealth funds and large pension funds to invest as well, but the typical check size will need to be a minimum of $100 million. Founders will be well advised to work with seasoned professionals who are current in this ecosystem and may consider placement agents when raising capital. New emerging businesses may, on a case-by-case basis, find happy homes with leading accelerator firms as well, whether focused specifically on agtech businesses or with a more general sector approach.
5. Plan for a longer road to profitability. Agtech businesses often require more time and capital to generate revenue and create long-term shareholder value. Agtech products require not only substantial initial development but also time-consuming testing in the field. Also, many investors want to see agtech businesses that have been “farmer approved.” Often seemingly transformative agtech innovations may appear to be incompatible with the practical realities of farming, and investors want to see that a technology is accepted by traditionally risk-averse farmers before investing further. Because of this, agtech companies likely need larger initial investments to cover lengthy product development and testing until more investors are comfortable participating.
6. Plan for an exit from the start. We counsel startup businesses to plan for the future, including the ultimate exit (i.e., an M&A, IPO, or other transformative event), and agtech startups are no exception. But for many startup businesses, the path to exit can be as little as five years. The nature of agtech startups should drive founders to have a longer time horizon, potentially spanning decades. It is certainly the case that large agribusinesses have been buyers of businesses in recent years, but wise founding teams will be prepared to access the capital markets and fund operations into the future. We would foresee greater use of joint ventures and partnerships in the future as well.