Editor’s Note: This is a guest post by DraperNexus, a US-Japan cross-border fund, focusing primarily on IT and industrial companies in both countries. Tomer Poran is an associate at DraperNexus, covering food & agriculture technology as well as IoT, spatial software and e-commerce. Deepak Jagannathan, who co-authored this article, is a senior associate and focuses on early stage investments in industrial technologies.

Love at first sight

We were drawn to agriculture technology by the promise that it was the next frontier for information technology innovation.

Providing services to a trillion dollar, stable (food is not a fad), and inefficient industry is appealing for startups and investors alike. So we decided to dive deeper to look at the risks involved, the market dynamics and the technologies being applied. The bottom line is: unless you believe some fundamental changes will occur in agribusiness, you shouldn’t invest in agtech. But we do, so we are.

A sober look

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The first challenge is the underlying market need. We hear this often in food and ag circles: “By 2050 the world will have 10 billion people in it, and we will need 75 percent more food. We’ll have to do this with much less land, water, and other resources.” This is problematic because most of the increase in demand will come from China and India; most of developed world population growth is stagnant. If they can marginally improve their agricultural productivity, then there would be enough food to meet the increased demand. In addition, while other asset classes require a 35-year outlook, venture capital requires solving urgent problems that persist in large markets, enabling rapid growth that will realize outsized returns. A slowly creeping food demand problem, primarily in markets with low buying power, is not going to drive venture-funded businesses’ success.

The second and biggest challenge in our minds is customer adoption. Different precision agriculture solutions that have been around for over a decade — and have proven to positively impact the bottom line — have only had single-digit penetration rates (besides precision steering, which has had relative success). Farmers are a technology distrusting bunch (on the whole), especially when it comes to data collection. Further, the local dealers whom they trust are fragmented and just as tech adverse. To grasp the adoption problem, just consider this: farm management software is, for the most part, not competing with Trimble, John Deere, Oracle or IBM tools; it’s competing with notepads and Excel spreadsheets.

The third challenge is the problematic financial metrics. Besides Climate Corp and maybe Precision Planting, there have been very few notable acquisitions in the past decade. Some smaller acquisitions have happened in biotech, much less around IT, and the exits do not compare well with other verticals in quantity or size. Raising Series C or D rounds has also been tough, even for well-known agtech startups, let alone reaching significant exits. A big concern for seed and other early stage investors is not only will someone buy my investment, but are later stage investors interested in what they are funding?

Lastly, finding agtech teams that have a balance of tech experience and expertise, and an understanding of agribusiness and farmers is much harder than in typical VC sectors. From e-commerce through semiconductors to embedded devices, the valley is swarmed with know-how and experienced entrepreneurs, and we can find qualified teams and conduct market and technology diligence more easily. To add to that, the underlying social need in food and ag innovation also clouds our vision as it is sometimes hard to assess if founders are driven to capitalize on a market need, or are trying to make the world a better place. A mix of both is good, but the former must be dominant for a company to succeed financially, in VC standard.

Hope and opportunity: How did we wrap our heads around these challenges to emerge optimistic about agtech?

The ‘market need’ problem. Is agtech needed to feed the world? Probably not. A slight increase in efficiency of row crops, more conversion of forestland in South America to soy fields (sadly), and African farmland becoming Chinese farmland is likely to solve the demand problem, mostly by supplying feed grain for the rising meat demand in developing countries. But we believe in a different underlying story:

– Consumer needs and behaviors are changing in the developed world, and this change will ripple upstream through the whole value chain.

– Agtech will enable farmers to spend more time with their families, and less time on the field, while increasing their bottom line. Let the drones, sensors and satellites take the night shift.

– Private Equity (PE), farm cooperatives, and corporate farms have accumulated more farmland assets under management in the past five years than they did in the previous 50. We see agtech as an integral part of their strategy to grow the value of their assets.

The market adoption problem. Farmers may be stubborn, but they are growing old — the average farmer is 58 years old with over a third past retirement age. They will either consolidate with corporate farms, sell to PE or pass the farm on to the more tech-savvy younger generation. All three scenarios are good news for agtech. There are also some large risks on the horizon that will push farmers to adopt efficiency and automation solutions faster than they normally would: water, labor shortage, sharp increases in input costs (especially fertilizer), as well as global competition from India and China.

As for conventional channels, different farm management software solutions — which can claim the highest penetration so far in agtech — could act as product discovery as well as procurement channels once they earn the trust of growers. This, along with cooperation with incumbents that have deep ties with conventional channels, could open up the “distribution clog” we are currently seeing.

The financial problem. Leading incumbents are also showing positive signals; from the strategic outlook in their SEC filings, to conversations they are having with VCs and founders — via Royse Law and through other forums — to joint development projects such as the recent 3DR-Agco drone partnership. While the acquisitions may not be frequent, the intent seems to be there.

Not only are the major “on-farm” players going to start paying up for successful agtech companies, but up the supply chain, “The Big 6” of farming inputs will gain value from the data and access agtech will provide. Down the supply chain, food processors, such as Tyson and Land o’Lakes, retailers like Whole Foods and Walmart, and emerging new players like Instacart, will all benefit from things like lowered variability improved supply chain management and more. This will make the entire value chain potential acquirers, as some already are.

As for later stage financing, we believe that this is a trailing indicator. If the A/B funds wait around until $40 million rounds happen once a month, most good A/B deals are probably taken, or at the very least, they are heavily contended. That crunch will solve itself as soon as the larger corporations start making their move.

Balanced teams are a problem that is already showing many signs of solving itself. More and more talented entrepreneurs with a true passion for solving the world’s large food and agriculture problems are emerging, moving from other industries they’ve had success in, and viewing food and ag as the next frontier. The proximity to some of America’s best farmland, and the willingness of farmers in these nearby growing areas to cooperate with Silicon Valley initiatives is bringing us a lot of optimism.

While agriculture and food are slow movers, the industry is very much a tail that wags the dog. Consumer behavior is changing, and with it the entire value chain, from retailers through to farmers, and all the way to the giant farming input producers. A newer generation of farmers and entrepreneurs, a more competitive global marketplace, and of course fruits of technology-enabled efficiency gains creating value for the many pieces of the supply chain, can push all the giant obstacles we listed aside. If you don’t think they can do so in the next few years, agtech is not a category you want to be investing in.

DraperNexus is a US-Japan cross-border fund, primarily focusing on the IT and industrials sectors in both US and Japan. We leverage our industry relationships in Japan, and the global reach of the Draper Venture Network, to create a customer development advantage for our portfolio companies. Over the last decade, we have helped several startups in the US and Japan expand beyond their traditional borders.