Backing auto tech start-ups can be fraught with risk, corporate finance lawyer Tim Leeson tells Paul Myles

Investors in cutting edge automotive tech start-ups have been warned to be wary of big-player takeovers that could ‘throw the baby out with the bath water’.

Tim Leeson a corporate finance lawyer and partner in the automotive team of the law firm Lewis Silkin said the wrong type of growth model could see investors with holdings that don’t count for much and that could be at risk from future product problems.

Speaking to TU-Automotive, Leeson said choosing the right growth models for emerging companies is crucial for everyone involved. Crucially, he explained, there are two models that can be applied to auto tech start-ups and it’s important to understand the risks involved.

Choosing the right model

He said: “You can take two paradigms – you can take the standard Silicon Valley paradigm where a business is set up by co-founders and they boot-strap for a while, then they need a small cash injection and go to an ‘angel’, then after a period of time it’s to a growth fund and then a venture fund and ultimately issue an IPO. So, you see a steady accumulation of people prepared to finance the business at each stage of its development and that’s a standard technology company growth pattern.” Naturally, the risks with this model are that the idea creators may not be the best people to grow the organisation as well or as quickly as investors may wish.

“On the other hand,” Leeson continued, “med tech, a paradigm that automotive may adopt, where if you are developing a drug you may get funding right at the start but when you reach the stage of having to run trials, the level of funding needed shoots right out of the roof. It’s a model that goes for £0.5M to £50M very suddenly. So it’s that trial phase that, generally, med tech companies are getting bought out by a large pharmaceutical company.

“It’s difficult to see which of these two paradigms will suit the auto tech start-ups best. I was involved in a transaction last year that was an ePerformance platform based in Magny-Cours that was bought out by Peugeot. That was using the med tech way of financing because they were struggling for funds for a while but with PSA they find themselves in a completely different place.”

Risk of alienation

While some take-overs by empathetic larger companies can work well, Leeson warned some start-ups and their potential investors may face risks. He said: “Personally, I would prefer to see automotive start-ups using the accelerator incubators that are around right now to go down the tech paradigm route, from seed right through to IPO.

“However, problems can arise when you try to transplant a few creative ideas people, who set up a small company, into a large concern. That’s because, increasingly, people want to be remunerated in equity – they don’t want to be an employee of a big giant organisation and want to work for their own company. Even if they sell it, they want to hold onto a stake in the company through shares because cash is not their driver.

“What interests me, as a corporate finance lawyer, is how you deal with that mind-set going into a large organisation. For example, you don’t want to buy a three-person business only to see that in six months time they are disenfranchised and alienated from the business because it’s just not them. You’ve spent a lot of money on their product and they are key to that product and, in the event you need a fix for the product, you’ll need those guys to fix it.

“So it’s important to get the equity ratchet right for those people or else you will lose them to the business.”

Insuring robots not people

Leeson also sees risks ahead for insurers as driverless technology becomes mainstream and definitions of who, or what, is control of the vehicles have to be thrashed out.

Leeson explained: “One of the major issues for insurers in automotive is who are they going to insure? It used to be when there had been a personal injury claim, they’d get a book out and say ‘broken leg, yes £8,000’ because there were clear tariffs for everything and that’s all motivated around insuring an individual.

“However, going forward, if the individual is not going to liable because he’s sitting there having the experience of a driverless car, who is going to be covering the cost of an accident or a death?”

Insurance 2.0

Leeson said problems insuring the technology are already apparent and that insurers need to adopt a different approach to stay relevant in the market.

He said: “Now, insurance 2.0, could be taken at the vehicle level, or, if you look at the standard automotive vertical, it is at the part producer level? Is the part producer, say, a software provider?

“With the Tesla incident, let’s assume, for example, the driver wasn’t watching a film. Automotive is not like aerospace where a pilot has a period of time and can take over if a problem occurs. In automotive that taking over time is very truncated. So if the Tesla driver had taken over immediately he was aware of a problem and, perhaps, still couldn’t have avoided the accident, who is responsible for that?

“If the insurer was insuring an individual who never could have avoided the accident anyway because he wasn’t driving the car at the time then he’s only really insuring Big Business instead of the individual. Yet, then, Big Business could turn round and say ‘but I don’t need insurance because I have a balance sheet worth so much that I could take on the risk myself’.

“This is a huge challenge for insurers because I don’t quite know who they are going to be insuring in future.”

Carmakers as risk takers

Leeson said it’s possible to envisage carmakers copper-bottoming their products by taking on all aspects of the legal risks in the clear knowledge that they would not be shouldering the responsibility alone.

He said: “Of course, if this happens a carmaker will look at his parts suppliers and if he thinks it was a software issue he will start negotiating with that supplier over who is responsible for the accident.”

Leeson said there is also a problematic legal aspect to what constitutes a driver in a driverless world?

He explained: “We are still operating in the UK under the 1988 Road Traffic Act where they didn’t see the need to identify what a driver was. I suspect by 2028 we will need a proper legal definition of what constitutes the driver of a motor vehicle particularly with the advance of autonomous vehicles.”

“More of our clients are raising these issues and this will affect the risk factors when considering financing an IPO or making a sale of a company involved in this area.”

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