Over the past decade, countless start-ups have benefited from a venture capital (VC) market that has seen steady growth in dollars invested and deals completed. Within the agtech sector,1 this increased level of funding was particularly transformative. In fact, approximately 20 times more capital was invested in new agtech ventures in 2021 than 2012,2 whereas VC investment in the overall market grew approximately 11 times over.
That said, agtech investment saw a precipitous decline toward the end of 2021, with overall VC following suit shortly thereafter (Exhibit 1). Although overall investment levels are still significantly higher than they were ten years ago, these recent declines raise a number of questions for agtech start-ups and investors, particularly given broader market uncertainty.
Given the overall growth of investments over the past ten years, we were interested in understanding how the recent VC slowdown could affect companies moving forward. With this in mind, we tracked the journeys of approximately 150 agtech start-ups over the past decade, observing the typical time between funding rounds and the increase in round size, which is a rough proxy for valuation growth (Exhibit 2). These start-ups were carefully chosen to represent five prominent investment themes: alternative proteins, sustainable materials, controlled-environment agriculture, digital and precision agriculture, and sustainable inputs (see sidebar, “Five major themes at the heart of agtech”).
The results show that although there is wide variation within and across investment themes, an agtech start-up typically spends 15 to 20 months between rounds, and funding levels typically grow from a median of $3.5 million in the seed round to $65.0 million in series C.3
Today’s agtech VC landscape: Reasons for optimism
Start-ups that raised money during the COVID-19 pandemic saw unprecedented amounts of accessible capital, allowing CEOs to aggressively prioritize growth, which was often encouraged by their investors. In the interval from third quarter 2020 to fourth quarter 2021, there was approximately 92 percent more capital available across all VC, and 110 percent more capital across agtech, than in the previous 18 months.
That said, start-ups that weren’t quite ready to raise funds in the past two years, as well as those that did so and aggressively spent down in search of rapid growth, now find themselves in a drastically changed fundraising environment. Coupling a reduction in later-stage VC availability with a slowing IPO market, dozens of start-ups have had to accept down rounds in 2022, leading to investor dilution without commensurate growth—and the economic pressures and uncertainty don’t appear likely to subside anytime soon for the overall market.
However, it’s important for start-ups to not catastrophize today’s market, which is trending more toward a prepandemic reset than a complete unraveling. Instead, as a first step, founders and CEOs should take a moment to determine where they stand financially and forecast how much runway they have left, with the expectation that most expenses will remain stubbornly high compared with prepandemic levels.
It’s a safe bet to assume that material costs will remain inflated for prerevenue agtech start-ups that are asset heavy and require significant capital expenditures for continued development and growth, such as controlled-environment agriculture, sustainable inputs, and alternative proteins. As we’ve learned over the past two years, nothing burns through capital faster than unexpected jumps in material costs during a build-out. For start-ups that are already generating cash, forecasting future sales under different levels of economic shrinkage can be helpful for determining where and when financial inflection points can occur.
Therefore, although it’s true that fewer deals are being inked and less money is available, there are three reasons for optimism in the months to come:
- Agtech funding may be down year-over-year, but it remains historically high and may be stabilizing. While second quarter 2022 saw a 36 percent drop from highs in third quarter 2021, it still represents more funding than in any quarter prior to fourth quarter 2020. In the third quarter 2022, agtech investment actually rose modestly relative to second quarter, whereas overall VC investments, now down more than 50 percent from their peak, continued to fall.
- A significant amount of “dry powder” (limited-partner committed funds that are yet to be deployed) remains in the overall VC market and with non-VC private equity investors, who can also serve as a valuable bridge for cash-generating start-ups that aren’t quite ready for an IPO.4
- Food and sustainability remain high-priority areas for a number of investors, particularly those with environmental, social, and governance (ESG) agendas, as evidenced by a less severe decrease in global sustainable assets when compared with the broader market and the repurposing of funds toward ESG.5
Three strategies for surviving the capital drought
In both good and bad times, timeless principles for start-ups still hold true. Navigating these principles, particularly when they seem to compete with or contradict one another, is all the more critical when the macroenvironment lowers the margin for error.
Successful start-ups can set ambitious yet achievable milestones that justify their target valuations, thus avoiding the natural inclination to play it safe during downturns, and continue to push the boundaries, albeit in a more strategic manner. This can help ensure that progress against key milestones demonstrates movement toward an attractive end state. All else being equal, a bigger business at maturity implies a higher risk-adjusted valuation at each stage of development.
In our experience, the perceived safe harbor of near-term opportunities can be misleading. Can you capitalize without adding significant cost and complexity to your business? Will that materially impact your valuation? For example, one biomaterials company shaped a “North Star” metric that framed early products as stepping stones to a much larger market opportunity, rather than end states in and of themselves. As a result, the focus was placed on derisking a massive opportunity versus maximizing much smaller opportunities, which proved a compelling vision for partners and investors alike.
Rapidly derisking core assumptions around technology, product–market fit, and the business model can effectively pull forward the valuation attributed to subsequent funding rounds, helping to create access to tomorrow’s capital today. Although it seems obvious, achieving milestones faster can increase year-over-year valuation growth rates, boosting a start-up’s attractiveness with investors in later rounds.
As companies mature, they can also reach an “escape velocity,” at which point it makes sense to change the rate of growth. In segments with heavy capital expenditures, such as alternative proteins and controlled-environment agriculture, there are typically early signs of a transition from pilot to production-scale build-out. However, it can be difficult to create the mindset and organizational capabilities needed to transition from lean derisking to scaling and seizing the opportunity. Leaders who can recognize the inflection points when parallel efforts no longer unduly compound risk have the opportunity to accelerate ahead of the pack.6
Start-up leaders can better manage their burn rates7 by eliminating distractions. Our experience shows that challenges stemming from a lack of focus typically affect two types of agtech businesses.
The first type comprises companies with versatile platform technologies with broad application space. Entering multiple value chains with drastically different customer needs substantially increases complexity. Companies that prioritize a relatively small number of applications (perhaps two or three) from the beginning can more easily demonstrate a platform’s versatility and hedge risk without diluting focus.
The second type comprises companies with more complex, tech-heavy businesses that require scientific or engineering expertise. Leaders of these companies sometimes believe they can solve every challenge themselves and that their company must control all the intellectual property (IP) in a given space. In the cultivated-meat industry, for example, there have been relatively few intra- or interindustry collaborations despite the large number of highly technical, complex problems that must be solved, such as growth factors, bioreactors, and cell lines. Particularly in times of funding uncertainty, start-ups should make trade-offs with respect to IP control versus growth while keeping an eye on the core sources of differentiation over the long term.
Capital droughts don’t last forever, and it’s important to remember that today’s level of investment in agtech remains significantly higher than it was five to ten years ago. Making the right moves now could mean the difference between riding market momentum in the years to come or falling behind.