Regulatory Changes & Investment Risk

by Jim Hardin

Regulatory changes can bring about new markets and new opportunities for innovators. Sometimes it is an upcoming regulatory change that entrepreneurs can react to, and sometimes updates in practices and technologies can bring about changes in regulatory regimes.

In my blog from last December, I talked about the upcoming regulatory changes regarding the use of antibiotics as a weight promoter in livestock. These regulations are already in force in some jurisdictions, resulting in producer’s greatly curtailing antibiotic administration except when medically indicated. As a result, an opportunity has been created in animal production that new Ag Tech needs to fill.

On the other side, regulatory changes may be something that companies need in order to commercialize their product(s). Investors assume their share of risk when committing capital to companies — that is just the nature of the business. In agriculture, however, that risk can be higher, especially in regards to the regulatory hurdles that entrepreneurs might encounter.

The agricultural industry in particular has extensive regulatory bodies, given that there must be strong safeguards in place to regulate food that is produced and that we ultimately eat. Many products must undergo regulatory review, especially genetically modified foods such as the non-browning Arctic Apple[1] and the AquAdvantage Salmon[2].

A sector currently gaining profile with investors is the use of drone technology on the farm. There has been a lot of investment and innovation in unmanned aerial systems. There are already many drone manufacturers around the world, targeted for use in agricultural management and precision farming, and a lot of venture capital money has been invested into drone technology specifically for agricultural applications, including $373 million[3] just in 2015. There are positives and negatives to using drones in Ag. One plus is that the payload can be customized on drones, so that the combinations of cameras and sensors can be tailored to requirements on the ground. They also offer a means for monitoring the fields throughout the crop year, as opposed to the occasional checks with satellite technology or field scouting from the ground. This allows for acute management of crop progress and growth. Its appeal to investors, and customers, is understandable.

However, as of late last year, the use of drones for commercial purposes was not yet allowed by the FAA, unless they had been granted permission either through the Section 333 Exemption, or through applying for a Special Airworthiness Certificate[4]. Drones can be used for research purposes, and for development purposes, but they cannot be commercialized. The FAA has indicated that they might have regulations drafted for the use of drones for business applications by spring of this year[5], but there is still no sign of what they will look like.

The space still has a lot of challenges. Consider the following: the drones being manufactured for this application right now have a payload of around a kilogram. This presents a security issue for the FAA, which points to significant regulatory hurdles regarding their design, which may mean that their capabilities could become constrained once (or if) they are approved.

Drone technology for agricultural applications is a high risk investment, with no clear path through the regulatory review process at this time, but the technology has strong attributes and people are ‘betting the farm’ on it. However, because of this risk, there are also venture capital funds that will not consider going into the space.

Evolving regulations form a large part of the risk assessments around the investment case in technologies such as drones. In the due diligence process, a risk as significant as this is a primary concern and comes up very early. The following questions need to be asked:

1) What are the regulatory barriers that exist?

2) What is known about the conversations around those regulations and the pressures on the regulatory bodies to evolve the frameworks? Is everybody happy with the status quo, or are they talking about revising these regulations?

As an investor, these considerations may affect your decision on whether to invest in these new technologies or not. Regulatory risks are much more difficult to assess, and timelines are often unknown. Sometimes things go your way (and certainly the changing landscape introduced by the start-up can influence this), but at other times there are unseen factors (ex. geopolitical influences) and/or other imperatives that result in no, or adverse, regulatory changes that can destroy the opportunity. Sometimes the technology is robust enough, or has broad enough functionality, to pivot to other markets but more often it is something that cannot be recovered. These are risks that all investors must thoroughly consider with every potential deal that they encounter.

My personal view is that there are enough good investment opportunities out there that adding another layer of commercialization risk to a potential opportunity might remove it from consideration. Given that early stage investing already carries significant risk related to management/market/technology/financing, layering regulatory risk on top of that is something that should be evaluated and priced appropriately.

[1] http://www.arcticapples.com/

[2] http://www.fda.gov/ForConsumers/ConsumerUpdates/ucm472487.htm

[3] http://www.cleantech.com/precision-agriculture-takes-centre-stage-as-the-drone-industry-ascends-to-new-heights/

[4] https://www.faa.gov/uas/civil_operations/

[5] http://www.reuters.com/article/us-usa-drones-congress-idUSKBN0OX1P020150617

This post originally appeared on the Verdex Capital website.

About the author:

Jim Hardin, Senior Investment Manager, AVAC Ltd.

Jim Hardin is Senior Investment Manager at AVAC Ltd., the parent company of Verdex Capital. Jim joined AVAC as an investment manager in 2006. Prior to joining AVAC, Jim spent over 13 years in academics and the biotechnology industry. Jim has a Bachelor of Science in Zoology and a Ph.D. in Gastrointestinal Physiology, and brings a broad background in life sciences to the organization. He has published over 100 patents, book chapters, full articles, and abstracts in the area of gastrointestinal physiology and animal models of infectious disease, thus lending an extensive background in life sciences. Jim’s focus areas include biotechnology, medical devices, and agricultural technology.

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