While private equity (PE) and venture capital (VC) are often used interchangeably as private investment models, they have different focuses. For example, PE focuses on more stable, established companies, larger equity stakes and lower risk profiles. VC, on the other hand, focuses on earlier-stage startups and higher-risk/higher-reward potential.
Yet there’s one thing that both of these investment vehicles have in common — an increased appetite for agriculture’s investment potential.
Investment in the agricultural sector has seen growing interest in recent years, with both VC and PE firms taking notice of the industry’s potential for growth and innovation. However, there are distinct differences between their approaches.
On the surface, each investment model provides needed funding to help agricultural firms scale and adopt new technologies. But each comes with pros and cons, objectives and things to understand.
The overarching theme? Investing in agriculture is not like investing in any other sector.
What PE and VC Find So Appealing About Agriculture
PE and VC firms find investing in agriculture so appealing for several reasons. One is the increased demand for food. UN data projects the world’s population to reach 9.3 billion by 2050. To meet this population growth, food production would need to increase by 50-60%. With recent inflationary shocks to food prices and supply chain logjams, there are questions about food security we’ve never seen before. Thus, investors have a unique opportunity to get involved in agriculture to solve these problems and meet the increasing demand.
Another reason is the increased attention given to Environmental, Social and Governance (ESG) issues. Growing awareness of climate change and protecting the environment has caused significant investor interest in sustainable agriculture. Investors are interested in companies developing solutions like precision irrigation, vertical farming, regenerative farming practices and sustainable practices that improve crop yields, reduce waste and increase efficiency.
Additionally, technological advancements mean that investors are also interested in AgTech companies that use tech like precision farming, automation and genetic engineering to improve agricultural production and efficiency.
One other reason is diversification. Investing in agricultural sectors can help to reduce the overall risk of a PE or VC investor’s portfolio since it’s less correlated to other asset classes.
Finally, many firms are attracted by the significant potential to achieve high returns in agriculture. However, much depends on the investor’s understanding of agriculture’s nuances and carefully analyzing market trends, technological innovations and evolving consumer demands.
One crucial factor for success is understanding agriculture’s market dynamics and supply and demand fluctuations. Moreover, it’s important to note that inflationary pressures adversely affect agriculture’s costs but do not correlate with demand.
The VC Focus
When VCs invest in agriculture, they primarily focus on AgTech startups. According to Walt Duflock, vice president of innovation at Western Growers, VCs often take different paths to chase investment returns. Sometimes the investments are focused on solving real problems like labor, water and food safety. Other times, movements like ESG influence investment segment choices.
The data corroborates this. AgFunder’s 2022 AgriFoodTech Investment report highlights that the Agrifoodtech category received $51.7 billion of funding in 2021. Of that, $18.2 billion went to upstream activities. Of the upstream activities, novel farming systems (which includes controlled environment agriculture, or CEA) and innovative food (which includes plant-based proteins) made up a combined $7.1 billion of the total $18.2 billion upstream investment category. The innovative foods category also had the highest deal volume of any major Agrifoodtech category, with 424 deals financed in 2021.
The Concerns and Pitfalls
Despite the VC investor interest in these AgTech sectors, more often than not, they underperform. CEA, in particular, garners outrageous valuations, despite mass layoffs and no clear path to profitability and positive cash flows.
Duflock describes the primary challenge facing VCs in their valuations: the need to look beyond media (and investor) hype and remember that in segments like alternative proteins and CEA, there are significant and scaled competitors already in place. Every inch of shelf space in retail stores will need to be taken away from a product that earned the space and does not just want to give it up to a new challenger.
One concern for the space is the prevalence of early-stage investing in Accelerators, Challenges, and Incubators, while there is a relative shortage of later-stage ($50-100 million up to more than $500 million) investment dollars that those early-stage startups will need later if they achieve product-market fit.
Practical Investments and Knowledge Sharing
As VCs learn more about AgTech and the practical solutions to invest in, they will hopefully make better investment decisions. Accelerator programs like the International Fresh Produce Association’s (IFPA) Fresh Field Catalyst are encouraging since they focus on innovative companies with solutions for problems like water and resource scarcity, climate change and labor shortages.
Duflock also says VC investments focusing on biological solutions that reduce chemical inputs could show promise in solving a problem while producing solid returns. In fact, according to Fortune Business Insights, the global agricultural biologicals market size is projected to grow from $11.66 billion in 2022 to $29.31 billion by 2029, at a 14.07% CAGR.
In addition, Duflock notes that more government-supported international delegations that can share knowledge and insights worldwide produce significant returns beyond just simply writing checks. Ultimately, while capital is important, it is also important to ensure that people aren’t trying to reinvent the wheel. Sharing best insights and practices between pioneering nations is critical to avoid missteps as innovative products and solutions are developed. Countries leading the way on this front include New Zealand, Australia, Israel and the Netherlands. All continue to send startups and delegations to the U.S. for major events and to introduce them to potential customers.
The PE Focus
PE firms have increasingly focused on investing in agriculture, particularly in produce and AgTech, over the past decade. Crunchbase data reveals that PE firms have invested $9.7 billion into agriculture as of Q1 2023, a more than 2.6x increase since Q1 2013.
Compared to VC firms investing in early-stage, unproven, primarily AgTech companies, PE firms look for established companies with solid market positions, brand value and a proven track record.
For instance, Scottish private equity firm Partners Group acquired Rovensa in July 2020 for $1.13 billion. Rovensa was established in 1926 and provides farmers with sustainable bionutrition, biocontrol and crop protection solutions. Israel’s Rivulis, founded in 1966, develops and manufactures micro- and drip irrigation products. Singaporean sovereign wealth fund Temasek Holdings acquired it for $420 million in December 2020.
Fighting Negative Perceptions
Many PE firms will argue that their agriculture investments can positively impact food security, climate change, sustainable practices and supply chain efficiencies. They will also say that their capital can help local communities and small-scale farmers invest in new technologies to compete globally.
Yet, there is potential that PE firms investing in agriculture face criticism based on their size and financial focus. In the United States, PE firms making agricultural investments often get lumped with “Big Ag,” or large corporations prioritizing profits over environmental and social responsibility.
However, it is essential to note that many big players in agriculture and PE don’t only prioritize profits. Instead, many make significant investments to promote ESG practices at a scale that producers using more traditional forms of financing cannot afford.
And scale is very important. Duflock provides an example of how scale matters and is impactful, even without a direct PE investment example. Walt uses Taylor Farms (the world’s largest salad and fresh-cut vegetable processor) as an example of a large-scale firm using its size and capital for ESG practices. Due to the increasing unreliability of California’s electric grid and the need to keep the lights and power on reliably in production facilities, Taylor Farms invested in a new and innovative energy solution. Working with multiple partners, Taylor Farms developed a microgrid using both solar power and battery storage to increase energy efficiency and reduce its carbon footprint.
The promise of PE investment in agriculture is to help achieve this type of similar impact with scale and speed.
Pros and Cons
There are several pros and cons of PE investment in agriculture vs. the more traditional model of someone procuring a bank loan with a down payment to purchase farmland and start farming themselves.
In terms of the pros, a PE investment can help deliver scalable efficiencies, and of course lots of capital can optimize business operations at scale and speed. It also provides exposure to a greater tech stack availability. In bank loans, the operator makes the personal guarantees, which limits growth.
As for the cons, the requirement or expectation of returns on investment can put unsustainable pressure on companies, and many fund managers may not understand the steep learning curve involved in this industry. In addition, more overhead costs are involved in producing high-quality accounting and financial reports for investors. On top of that, oversaturation can lead to overpriced assets. Fund managers that don’t properly understand the demand dynamics of an industry like agriculture can oversaturate and destroy profitable commodity markets.
Balancing Long-Time Horizons with Yield-Hungry Investors
PE funds have two structures. The first is an evergreen fund focusing on long-term investments, consistent cash flows and a lower return profile. This type of fund focuses on investing in sustainable businesses over the long term and aligns more with agricultural investing since it has a long time horizon.
However, the second, more common PE fund type is a short-term fund. With a 7-10 year time horizon and goal of achieving double-digit returns, this structure can be problematic with agricultural investing. Not only may this type of fund be more susceptible to criticisms of focusing on short-term profit maximization and agricultural exploitation, but it could also lead to rapid scaling, an oversupply of goods and potentially harmful consequences to the overall supply and demand equilibrium. Plus, investing in a completely new development with a 10-year fund horizon is unreasonable because crops require significant time before yielding any harvest.
The most effective approach to address these concerns is to allocate more short-term fund investments to established operations that require minimal development and allow for immediate technological advancements and more efficient farming methods.
What Makes PE So Attractive in the Fresh Produce Space?
Agriculture is a highly specialized field with many unique challenges. For investors that lack the knowledge and experience yet expect high returns, they may be in for a rude awakening. The learning curve is steep.
However, due to several factors, many see PE as an attractive investment option in the fresh produce space.
First, PE enables rapid expansion. A PE investment helps companies quickly scale up their operations, capture a larger market share and exploit new opportunities.
Another factor that makes PE attractive in the fresh produce space is that the cost of goods sold (COGS) is not supply and demand driven. Therefore, companies can often control their costs better rather than being susceptible to market forces beyond their control.
Is Crowdfunding a Viable Alternative?
Crowdfunding has emerged as a potential alternative funding source to PE for agriculture businesses. It can provide access to capital and a broader pool of potential investors; however, it also comes with challenges.
One of the benefits of partnering with a PE firm is that they often take a holistic approach and provide more funding than crowdfunding campaigns. Through their resources, PE firms can also bring operational efficiency and scalability to agriculture businesses. Due to its novelty and the need to market to investors with lower upfront investment requirements, crowdfunding may fail to achieve these objectives and result in slower fundraising.
Additionally, crowdfunding may make investors more prone to invest in agriculture businesses based on emotions rather than rationality.
The only real way for crowdfunding to work in agriculture is for everyone to be as transparent as possible. People may love the opportunity, but it will only work if there is clarity, openness and honest reporting.
The Future Outlook for PE Ag Investing
Current trends in not only the investment world, but society as a whole, suggest significant potential for growth and development in the agriculture sector. As consumers become more interested in sustainable and ethical food production practices, it’s opened up interest in several agricultural sub-sectors that could see considerable interest from PE investments. Regenerative agriculture is one sub-sector. Others could include emerging technologies that help businesses reduce their environmental footprints, like automation, precision farming, vertical farming, smart irrigation and more.
However, agriculture is a complex industry that requires unique knowledge and experience. It’s also often capital-intensive, with slow and steady returns. The industry also faces several headwinds, such as economic conditions, climate change and the always-evolving consumer trends. Plus, for yield-hungry investors, agriculture does not always provide high returns in a short time.
The Key Takeaway
As consumer preferences demand sustainable agriculture practices, investors have the opportunity to both profit from and support agricultural businesses committed to environmental stewardship.
While VC investors focus more on gambling on early-stage, unproven AgTech companies, PE investors can shape the industry by deploying significant capital into smart agricultural investment decisions beyond just the potential returns. Their capital can also promote sustainability while helping local agricultural communities instead of exploiting them.
As much as 40% of farmland will change hands in the next couple of decades, making it critical for PE firms to consider the long-term impact of their investments. Walt Duflock’s idea of giving back to the community by allocating 10% of their employees’ time to local initiatives is one small step that can go a long way.
Of course, this is all easier said than done. However, the agricultural industry will thrive in these uncertain times with a thoughtful and nuanced investment approach that considers all parties involved.