Can higher interest rates save agtech?

Prime Future 167: the newsletter for innovators in livestock, meat, and dairy

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“Low-interest rates gave the U.S. economy a lot of new real-estate businesses it probably didn’t need. A.I.-powered house flipping, luxury timeshare startups, apps and platforms for everything from bidding on rent to showing office tenants where the conference room is—they all emerged from a seemingly endless stream of cheap money that no longer exists. Some may not survive.”

This was from a WSJ article on how interest rates are impacting the real estate market as the consensus view of investors shifts to the assumption that interest rates are likely to remain higher for the foreseeable future.

We can say almost the exact same thing about agtech, right?

I'll admit that for most of this year, I have looked around at agtech and thought, 'What are we even doing here?' While there are some really bright spots to point to, they are few and very far between despite billions invested. I’d been wondering if this is a blue ocean with the potential to create long-term producer and consumer value or if agtech had become a murky sinkhole.

I don’t want to be a critic of those in the arena, but Indigo’s big news this week is a brutal example of easy money in agtech. According to Pitchbook, Indigo has raised $1.7 billion to date. Their last valuation was $3.5 billion in 2021. Until July 2023, when they raised an undisclosed amount at a $200 million valuation. 94% of equity was wiped out. 

But that is shocking only to those who haven't been watching the Indigo story for the last decade. Shane Thomas published a great analysis of the drivers and assumptions that is definitely worth the read. Here’s a rough summary of the company’s evolution over the last decade:

The company started in 2013 with a seed treatment, then hired a CEO with a marketplace playbook who, not shockingly, applied the same playbook to a new industry. Suddenly, the well-funded company with a seed treatment was spinning up vertical marketplaces in commodities like corn and soybeans.

While these types of marketplaces fail for a number of reasons in ag, no other player had as much funding as Indigo when attempting this playbook so it seemed like there was a tiny chance it might work. But a few years into that experiment, the red flags were on fire - like why they were paying close to 2x market rates for salaries and why they only talked about the value of what was listed on the marketplace, not the value that actually transacted (a classic way to make a marketplace sound more robust than it is).

Finally, they (privately) called it that the marketplaces didn’t work, the CEO was out, and the company went hard at the next great wave: carbon. And now here we are. 

I am not drawing conclusions about anything other than the fact that this wasn’t even the classic challenge of technology in search of a problem; this was excessive amounts of venture capital in a decade-long search of a real business.

The scale of this phenomenon could only happen in an easy money low-interest rate environment.

And I like to think that higher interest rates will drive that kind of silliness out of agtech, leaving only serious companies tackling high-value challenges.

In a recent episode of the podcast "Invest like the Best", investor Jeremy Giffon framed up part of the problem:

"Venture capital started to fund high cap ex businesses with very low probability of of success that if they did succeed, would have humongous outcomes. And your average software company does not hit any of those marks.

If you're going to raise venture capital, you should have a very good reason. But most people raise venture for 1 of 2 reasons: 1) they don't know what else to do and it's the default path for starting a business, or 2) it's just easier.

Most businesses you could bootstrap the business by selling a customer and getting them to pre-pay. But that's hard. And its easy to go get a couple million bucks and you go get an office and pay yourself a salary.

Venture has become the default path when it's actually a very niche tool."

Let’s replace the word ‘software’ with the word ‘agtech’ in Jeremy’s first sentence and we get this truism:

"Your average agtech company does not hit any of those marks"….yet raising venture capital has become the default path?

I think that's about to change.

Higher interest rates mean investors can get more risk-free returns than they've seen in decades, which creates less incentive to put capital into risky assets to seek returns, like venture funds. If less capital goes into the entire venture capital asset class, it's reasonable to assume that some agtech venture firms will go out of business. Fewer agtech venture firms likely means there's less capital in the agtech segment of the venture capital asset class, and it likely also means that capital is more concentrated within fewer firms/funds.

Only so many investments get made out of each fund, which is, of course, fund size dependent. AND only so many investments get made each year by each general partner at the fund.

All of this adds up to a high likelihood that it gets much harder to raise venture capital for agtech companies in the foreseeable future than it has been over the last 10-15 years.

And frankly, I think that might be a great thing for the ag industry because it will force real focus on real problems with real solutions.

Venture capital is a phenomenal tool to drive innovation when used correctly.

The world doesn't need another Indigo, hoovering up capital and creating minimal value for farmers or anyone else in the value chain. The world doesn't need another plant-based meat company or another venture-backed farm management software company.

What farmers & ranchers & processors & consumers need from agtech is products that create better outcomes, whether lower cost, higher revenue, less risk, higher quality, better nutrition, or any of a million other ways to drive value. But real value.

The caveat is that some of the best venture-backed companies do like crazy in the beginning; they have a non-obvious solution. But there’s a lot of white space between bringing a non-obvious solution to market and whatever you call some of the most well-funded companies of the last decade.

Not to mention, if founders move away from a default path of raising venture capital to start companies, it should lead to more new companies bootstrapping (customer-funded via revenue for a real thing someone is willing to pay for), and that will drive a whole different type of discipline and approach to innovation. It will be harder but may very well lead to better outcomes.

All of this makes me think about how agriculture is a real industry where common sense is rewarded.

Real in the sense of the physicality of it - you can hold soil in your hand and feel the hide of a steer or (regrettably) carry the smell of a chicken house in your nose for a week after the fact.

Real in the sense that it cannot escape the fundamental laws of supply & and demand.

Real in the sense that agriculture is exposed to the whims of weather.

Real in the sense that producers are ever aware of macro factors like interest rates.

Real in the sense that to ignore the realities of economics is to be a short-time player. 

I’ve recently had a conversation with a few startup founder friends in the unique (in the startup world) position of running profitable businesses. The irony is that they almost question whether they should have prioritized growth over profit.

But profit gives startups a degree of optionality that venture-dependent companies do not have.

Profit is real. And venture investors are starting to reward that reality. But clearly, profit is not suddenly a good thing.

Profit has always been a good thing; it’s just suddenly being rewarded by venture investors.

Just like in hindsight, it was absurd in the dot com era for pre-revenue companies to IPO; it seems likely that we’ll look back at the last few years of prioritizing high growth the same way.

If we are moving into a sustained period of higher interest rates relative to the last 15 years, as many are predicting, there will be some negative implications in ag. It’s going to get harder for producers, but hopefully, the story ends differently than the 1980's did.

But for agtech? I think higher interest rates might be the best thing that's happened to agtech in years.

Here's to the upside of a return to reality.

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