How's private equity going to play out in AgTech? Depends how it plays out in ag.

There's been a lot of discussion about the capital situation in AgriFoodTech (aka AgTech). There are a few reasons why capital is becoming an increasingly common topic among growers, investors, and startups. First, venture capital took a 50% drop from 2021 to 2023 ($354B to $171B) as IPOs dropped by 85%. So the overall VC space is cooling way off - with a slight uptick in 2024 (which is somewhat fool's gold because it's virtually all on AI so one healthy segment masking a lot of not so healthy ones). Second, AgTech venture capital went down 70% from 2021 to 2023 ($53B to $16B) and stayed flight in 2024 at $16B primarily due to the dumpster fires of over-hype known as vertical farming and alt-protein (those 2 categories were 42% of the $53B and both are ending horribly and very visibly). It's fair to say that overall VC and AgTech VC will struggle until exits return. It's also fair to say that IPOs in AgTech are rare so the return of AgTech VC will depend on the A in M&A - yep, acquisitions need to pick back up in a market where grower revenue is down 30-40% in 2 years so John Deere and Bayer (and folks that look like them) have particularly light wallets right now which makes a pickup in M&A unlikely.

So in an opening paragraph we've got a Defcon 1 situation for VC, AgTech VC, and corporate (aka strategic) VC - all are in distress and unlikely to recover soon. But we've got a lot of startups that were funded during the last 5 years, a couple of which were go-go years and the biggest of which was 2021 with $53B. Many of them are going to need capital and those were their major sources. So what will they do instead - or more accurately what will happen without capital for later investment rounds and acquisition checks? Well, this is where the private equity space might get involved in one of two ways (or both): (1) continue a trend of becoming farmland asset owners or farming operator assets; (2) purchase some value or distressed asset AgTech startups, potentially to operate or do roll ups and integrate multiple startups together with a common sales team and go-to market model.

The first option has been going on for a while. Private equity, and indeed many types of institutional investors have been investing in farm land and farm operations for a couple of decades. They invest with a multi-pronged investment thesis:

1) Farmland Appreciation: Farmland has been an over-performing asset class for decades and has out-performed almost every other asset class while a lot of folks didn't notice. That changed in the last 20 years or so as asset managers sitting on large piles of cash decided that putting some money into farmland made sense. Best case - the farmland appreciates in value and the owner decides if and when to liquidate. Worst case - farmland depreciates but as an underlying asset it will never go to $0 like other high-risk asset classes (i.e. venture capital).

2) Groundwater Appreciation: Riparian rights include both surface water (water which stores and flows over land like lakes and rivers) and ground water (water stored underground in aquifers). For a lot of agriculture land, including California and other specialty crop regions, both types of riparian rights run with the land and can be valued based on whatever the market is willing to pay to buy some of those riparian rights (can be short term or long term). California has seen significant appreciation in groundwater values when marketed by the acre foot (the price of enough water to cover an acre of land with a foot of water) over the last few decades as the water user count has grown from population growth while minimal investment was made into surface water storage (additional dams), increasing the demand for a constantly decreasing resource as drought combined with lack of storage to make groundwater a more scarce resource than ever. This is the second investment thesis investors can use for farmland acquisition.

3) Increased Operational Efficiency: investors that have enough capital to aggregate large amounts of acreage and run them as a single integrated operation with vertical integration from the farming to the production facilities to logistics can often deliver better per acre economics, particularly if they are able to invest in AgTech solutions like automation and water efficiency. Sometimes investors can buy both acreage and a production facility to create a vertically integrated grower operation. Now it is worth noting that not all of these have gone well. In the case of Prime Wawona, Paine Schwartz learned some painful lessons about the limitations of operational efficiency relative to underlying economics and the attempt to "private equity" tree fruit crops did not end well. But the thesis remains valid - if you can own enough acreage and get vertically integrated, there are economic opportunities to create a good business and investment return. Scale has advantages related to acreage you can spread costs over and vertically integrated operations where you can control more of the total supply chain economics.

4) Crop Rotation: In some cases, I've talked to investors considering making farm land asset purchases and one of the topics that came up was crop rotation. This is relevant because of water considerations, particularly in California with the Sustainable Groundwater Management Act being implemented with potential allocations of groundwater that will force farmers in high-risk water basins to fallow land. Obviously the worst crop to have in these situations is a permanent crop, including tree crops or vineyards, where fallowing for a year means the crop dies and it's useful life is ended. It's far less risky to plant rotational crops where a fallow allocation means the acreage is just not farmed for a season of a year. Having enough capital to make a crop switch and base the underlying economic model on a new crop type gives an investor more flexibility related to that acreage.

So there are 4 potential investment theses for farm land or farm operations investors: (1) return from equity growth in the underlying farm land asset; (2) return from value growth in the riparian rights, usually groundwater rights, associated with the land; (3) operational efficiencies from having a large acreage count and/or a vertically integrated operation; and (4) crop rotation strategy which can improve the economics while mitigating the risk of not having water. Each of these four could support a farm land or operation investment under the right scenario. The reality is that for many farm land acquisitions, all 4 of these individual theses are in play, which is part of what makes the return potential so interesting to investors with big capital stacks and a long investment horizon.

So this first option is ongoing - private equity (and other investors) continuing to pile into farm land or farming operations because the return potential is significant and in the absolute worst case the underlying property should always provide some recoverable capital if everything goes sideways.

The second option is not as ongoing but is likely to show up at some scale. This option involves PE (or similar investors) buying AgTech startups. The opportunity in this case comes from the $200 billion invested into AgTech startups over the past several years. Even with a 70% decline from $53B in 2021 to $16B in 2023 (and 2024), there has still been over $100B invested since 2021 ($53B/$32B/$16B/$16B from 2021 through 2024) and another $100B invested on the run up to the $53B. Many of the startups that received some of the $200B in venture capital are out there in various conditions - some can still become long term success stories, some are stuck in tough conditions and in "heads down / duck and cover" mode knowing capital is getting tougher to raise, and yes some have ceased operations. Many of them were heads down on product and have not gotten to the commercialization portion of the exercise, so there's no revenue to drive an acquisition price or valuation.

Consider two segments we work with a lot these days - automation to help solve labor and biologicals or genetics to help solve chemistry challenges. There are at least 700 robotics startups and at least 1,300 biological startups and more emerging in each category every year. That's over 2,000 startups with all different types of fundraising happening to them. With the 70% drop in venture capital it's fair to say an even higher percentage of startups than normal in key categories like these are likely to fail. This means that 90%+ are likely to be in a position where they would be available for a private equity buyer if the terms and price were in the right range. So let's assume a baseline of 1,900 startups (95%) and counting as new ones are added to the pool each year will be potential acquisition targets. This is an appropriate situation for private equity to get involved, but involvement and investment is not without challenges.

One of the basic premises of the private equity model is that PE investors have a strong preference for having a revenue stream and margin they can determine a value for - but a significant percentage of AgTech startups that are likely to be acquisition targets are pre-revenue and even higher percentage are likely to be something other than cash flow positive. Both of these realities make the acquisition much more challenging. PEs prefer to buy and hold without needing to invest additional and ongoing cash at the startup (or startups for roll ups).

So as much as this looks like a likely scenario for acquisitions or rollups, the reality is that the early stage and pre-revenue nature of many of the startups makes it a tough fit for a lot of PE investors. They like to take operations that have revenue and run them better or combine them with other companies that can help push revenue growth. That's not the normal scenario with AgTech startups.

The far more likely scenario is that private equity continues to see farm land and operations as a more attractive investment portfolio. And if you think about it this could be the best result for AgTech startups. Why is that you may be asking? Because if private equity continues to buy farm land and farming operations, think about the investment thesis. The way they turn the PE investment into a solid ROI is to increase the farm land value, the groundwater value, the operational efficiency, or the crop rotation. The two items that can most commonly be improved through solid strategy and operations are groundwater via water efficiency and/or treatment tools and operational efficiency via automation and other solutions. The key worth noting is that for the investment to pay off, they are going to need to buy AgTech and they are going to need it to work or the returns will not meet their targets. In fact, some of the PEs I have talked to about possible investments wanted to discuss potential technology stacks that could drive the targeted efficiency goals.

Those goals are going to be tough to meet. A lot of AgTech startups are going to need additional capital - that's why the model suggests 1,900 likely to fail startups in just 2 AgTech segments (admittedly two of the larger segments to date and likely to be larger segments going forward). The capital is needed to help push growth to get to cash flow positive. But capital to grow can come from two sources - investment capital or sales revenue.

And this turns out to be the key reason why the agriculture ecosystem should root for continued private equity investment in farming operations over PE investments in AgTech startups. If PE comes to startups, it will still need sales revenue growth to really get those startups into a strong commercialization position. But if PE comes to farm land or farming operations, it then uses the capital it needs to support the investment to make AgTech purchases which is the best way for the PE to deliver solid financial returns and the best way for AgTech startups to grow. Again, eyes wide open on potential PE challenges (recall Prime Wawona) but PE money can support growth if applied to farmland or farming operations that then need to invest in AgTech to deliver targeted returns.