In a recent issue of MODERN TRADER we panned Yayyo, a new Reg A+, pre-IPO, offering (see “J. Peterman is pitching this IPO,” MT August 2017). But don’t get us wrong, we are advocates of the liberalization of non-accredited investor access to private offerings under the JOBS Act. Nevertheless, we caution our readers that these private, often pre-revenue, early-stage companies require more intense scrutiny and due diligence. Knightscope scores higher than Yayyo (see “Trade or fade,” below).
Knightscope is one of the many startups in the recent past to make use of the new Securities and Exchange Commission Regulation A+. Reg A+ became effective on June 19, 2015. It’s been more than two years of allowing the public to invest in private companies and “mini-IPOs” of startups and several companies have raised millions of dollars. Regulation A+ allows Tier 1 and Tier 2 offerings. Under Tier 1, companies can raise up to $20 million each year from institutional investors and main street (non-accredited) investors provided they satisfy some state registration requirements. While under Tier 2, companies can raise up to $50 million each year and there are no state registration requirements to be satisfied. Due to the registration hurdles with Tier 1, more companies are making use of Tier 2, and succeeding. Under Tier 1, there is no limit to the amount non-accredited investors can invest. However, under Tier 2, a non-accredited investor is limited to investing the greater of 10% of one’s annual income or 10% of one’s net worth excluding the principal residence. Investors simply self-verify their income or net worth by completing a form. This is a per-offering limit and not a per-investor limit. Knightscope is a Tier 2 offering.
People who invest in the future of a business or startup are generally more likely to recommend the particular company and create a positive image of it. Apart from raising capital with fewer regulatory hurdles associated with a traditional public offering, “mini-IPOs” under Reg A+ help build brand awareness and act as a marketing tool. Companies have a greater potential of fundraising, as they can sell securities to both accredited and non-accredited investors. Since a large number of people can invest, ownership is not confined in the hands of a few and at the same time investors do not have as much power as shareholders do in a typical private equity offering.
To enhance the offering’s marketing appeal, Knightscope throws in some noise in the way of investor perks. Invest $999 (Bronze) and get a custom t-shirt designed by Knightscope. Invest $10,000+ (Silver) and you also receive a replica toy model of one of the security robots and an invitation to a media event. More perks at $25,000+ (Gold), and if you invest $100,000+ (Platinum), the complete package including airfare to Silicon Valley for a private tour of Knightscope’s headquarters, dinner with the Knightscope management team, your signature on a machine signed at production and a professional family photo shoot with the K3, K5 and K7 series robots. Yes, Mr. Li certainly has a flair for marketing.
But more substantively, early-stage Knightscope and its robots are very much in motion. On Aug. 15, Knightscope achieved a $10 million milestone in the Reg A+ mini-IPO preferred stock offering, one of the most successful crowdfunding maneuvers in the history of SeedInvest, its designated crowdfunding platform. This mini-IPO is an addition to the prior raised $14 million+ in financing secured during their seed, Series A and B Preferred financings. The CEO recently received an Upstart 50 Inventor Honor Award and the company was nominated for Silicon Valley’s Best Tech Startup.
The company is very early in development, and in revenue, and is far from profitability. It reported a total loss of $3,392,277 and $5,472,547 in 2015 and 2016, respectively. No matter how promising the idea seems, it comes with challenges. The security bots can be perceived as a cost over and above the traditional security guards budgeted for. Another question is that since these bots are available as a service and control will be shared with Knightscope, will large companies in technologically sensitive industries be comfortable with that arrangement?
A look into Mr. Li’s past reveals that he and a co-founder were at the helm of failed Indiana startup Carbon Motors in 2013. The local government gave Carbon Motors $7 million in grants for a production facility that was supposed to bring 1,300 jobs, but instead declared bankruptcy while owing another $21.7 million to private investors after the Department of Energy denied the company’s application for $310 million in loans under the Advanced Technology Vehicle Manufacturing program.
We investigated Carbon Motors expense records and did not view the spending to be atypical of an early stage company in business development mode. No red flag from our perspective, as startups and serial entrepreneurs frequently fail, particularly when nine figures of anticipated mission-critical investment fails to materialize. Moreover, Li’s executive history and accomplishments at Ford Motor Company (F), building the world’s second largest automotive recycler, give him the leadership cred required to jockey this company out of the gate.
There have been several bot mishaps. In addition to the incident in the parking lot with the drunken man knocking over a robot, a K5 security robot ran itself into a water fountain inside an office complex in Washington DC and was rescued by human security guards. A year ago at Stanford shopping center a K5 security robot bruised a child’s leg causing it to swell. While these foreboding instances offer some humor and a glimpse of futures sitcom scripts, we hardly view these as red flags that should deter investment consideration. We have very little doubt about the ubiquitous proliferation of self-driving cars in the future, but expect many accidents along the way.
The investment thesis
With no current direct competitors, Knightscope’s products are designed to supplement the work of security professionals instead of replacing them, and are suited to most environments that require security patrol coverage. Globally more than $500 billion is spent on security each year and Knightscope aspires to reduce this spend. With Knightscope offering its bots at $7 per hour (all-inclusive), companies can save materially on their security budgets while providing unprecedented situational awareness tools for the security team themselves.
These bots make use of autonomous technology solutions and operate on a Machine-as-a-Service (MaaS) business model. Robotics, predictive analysis, big data, autonomous technology, sensors and software provide real-time data delivery to Knightscope customers. With features including a 360-degree video for night and day, a two-way audio system, thermal imaging and data collection, Knightscope currently has two running robot models in production and two more on the way. The K3 is small, compact and maneuverable for indoor use and the K5 is a larger robot for outdoor use. It is five feet tall and weighs 400 pounds. With more than $14 million spent for research and development and deployments, Knightscope is planning to use the proceeds from the mini-IPO offering to develop the K7, a four-wheel version of their ADM technology intended to operate in a wider range of challenging terrains. The alpha engineering prototype phase of the K7 multi-terrain machine is complete, and the beta engineering prototype is underway. Later in August, the company announced the addition of a new robot to their portfolio of Autonomous Data Machines; the K1. It includes concealed weapon detection and radiation detection, for which the proof of concept prototype is complete and work on the alpha prototype is underway. Both the K1 and K7 will begin shipping in 2018.
The bots are employed. Malls (Westfield), corporate campuses (Samsung), and healthcare facilities (Dignity Health) are utilizing them today and Knightscope counts contracts signed with more than 30 clients in eight states and three time zones.