Are AgTech & VC a good fit?

Half of the investment raised by UK Agritech companies comes from Venture Capital (VC). It is critical in bringing new AgTech technologies to market and changing the way we produce food and fiber. Yet this type of capital has significant drawbacks the goal is to use AgTech to make farming more profitable, productive, and sustainable.

The question of fit is relevant despite the “not all VCs…”, or “not all AgTech companies” push-back. Unless we recognise the misalignment of expectations & incentives, and the areas of mismatch between the needs of VC, AgTech companies, agriculture & the environment, we risk the AgTech revolution failing to achieve its potential.

Beauty is in the eye of the beholder

VCs have a business model which, as this earlier article explains, relies on a handful of investments to generate outsized returns. A demanding list of criteria is therefore typical prerequisites for a VC to invest, including the potential for the company to become highly valuable very quickly.

VC firms screen dozens or even hundreds of hopeful companies for everyone they invest in, seeking those that meet their criteria & a promise of a strong return. This has worked famously well in software, gaming, and other high-tech sectors; even in healthcare & biotech. But companies that operate in agriculture often have characteristics that do not align brilliantly.

So, is AgTech a good fit for VC? Why does this question matter?

A question of fit

Timescale It often takes a long time to develop an AgTech product or service to commercial readiness. This has implications for R&D costs, and for the time that capital is tied up.

First, many AgTech companies have unique rate limiters on product development cycles. For instance, a harvesting technology can perhaps only be trialed at harvest, which in any given geography only happens annually. Other natural world impacts, such as drought or disease, can further frustrate progress.

Second, the problems the companies seek to address are often particularly messy and complex. Examples might include using imaging and robotics to distinguish the signal of harvestable produce from “noise” or influencing soil biology across diverse soil types and climates. This complexity increases both capital investment in R&D and the time to revenue or profitability.

Adoption Tech adoption rates are pretty slow in agriculture, which means typically slow revenue growth for a nascent AgTech company. This usually has implications for the rate at which a company grows in value.

To illustrate, arguably the most successful AgTech innovation is the introduction of GPS control into large farm machinery. Yet 20 years after introduction, only c.50% of crops in the US farm with this, likely lower in other countries. Why adoption is slower in agriculture is much researched … but start-ups and investors should not underestimate it.

Physicality Agriculture is at its heart a physical-world business. For AgTech this often means capital intensity and customer variability.

One reason, is that Farmers are tied to their land, and agricultural produce is physical. This means physical assets – for inventory, distribution, and production of prototypes – implying capital intensity. Physicality also makes it hard to reach customers, especially when farms are, almost by definition, dispersed and often remote. This has implications for distribution, servicing & infrastructure which many digital businesses do not face.

Another issue: the physical nature of farming means huge variability across the potential market in practices, regulation, species, soil types, climate etc. A corn farmer in Iowa will have a different set of requirements in almost every way to one in the Rift Valley in Kenya. Individual addressable markets can be surprisingly niche and adaptation to multiple market types is costly.

Disruption. To disrupt a market by doing things radically differently is the epitome of the high-risk-high-return opportunity that VC was designed for is. Yet food and agriculture have some structural barriers to disruption. We need to eat physical food, and consumers are not very open to radical disruption in what they eat!

Meat grown in tanks and veggies in warehouses may be exciting to an investor but even if novel techniques develop and play a role, cultural attachment to food & the sector’s roots in biology limit the scale of transformation opportunity (see this article about Controlled Environment Agriculture).

Implications

Does it matter if AgTech is not a perfect fit for the classic VC model? For at least three reasons, the answer is “Yes”.

Shifting Tides, Cost of Capital. There is a lot of appetite to invest in AgTech – $15.8bn invested in”upstream” ideas (of $26.1bn in AgriFoodTech) during 2020. This is due to AgTech’s tremendous scope for innovation and environmental impact potential.

Will this last? If the returns on investment aren’t realised, the tide could easily turn.

Sectors come and go in popularity – just ask the Cleantech sector which boomed in the early ’00s before investor interest waned. A retreat might be triggered by slower than expected growth, insufficient exit opportunities (the value chain for inputs into primary production and buying the produce from this sector are highly consolidated). Or simply, lack of novelty!

If VC decided this sector is not the right place to put its efforts, the cost of capital to future start-ups will increase, stifling innovation in the sector or starving companies in the development and scale-up process.

What gets funded. VCs, even those focused on impact, are not in philanthropy. This means, ultimately, hard financial impact will trump hard environmental benefit, and financial return to investors will trump benefits to the agricultural sector or society. The implication: potentially important ideas may not get funded or scaled sufficiently to achieve their potential.

Many AgTech companies are fairly close to VC comfort zones, such as digital marketplaces for agricultural products or data management companies. Others – perhaps a hardware innovation that transforms damaging soil management practices or a transformative hydroponics substrate – might struggle to raise investment, grow at a slower pace, or may even have their ventures culled.

This matters, because there are so many ways we need to improve how we grow, harvest, transport, and store physical goods. We can’t eat data – investment-friendly digital solutions alone are not enough to transform food production.

The Environment. Lastly, despite the rise of “Impact Investing”, there is imperfect alignment around the businesses that will generate the most return for investors and those that will most benefit the environment. We risk big opportunities to benefit biodiversity or climate change being overlooked in favour of smaller impact opportunities more in line with investors’ financial or cultural expectations.  

The baby and the bath water

What should be done about this? Turning our back on the VC world would be churlish. The priority is to nurture and shape the features most compatible with the needs of AgriTech and be creative about addressing the gaps.

Three steps must be taken:

1. We must recognise and be transparent that AgTech has its own peculiarities. If we can avoid the temptation to exaggerate the opportunity the sector, and be transparent about the risks the greatest threats of misaligned expectations may be averted.
2. The agricultural and research communities must cooperate with investors to create evidence-based transparency about where the greatest environmental impact can be had. Impact investors are flocking into Agritech with a specific mandate to benefit the environment through their investments. They can’t be expected to know the nuanced realities of farming without shared data and insights.
3. The agricultural community should itself start to more actively shape investment models that tap into its own value system, preferences, and needs. If a startup’s idea is important to the farming sector but not sexy enough to the VC community, what other mechanisms could support that development? Innovation is happening in start-up investment: creativity about alternative ways to generate a return for Agriculture needs to be accelerated.

Perhaps, the big dream is that the 4^th Wave of AgTech Innovation does not just transform how we produce our food and manage our land, but creates an entirely new way to support startups.