5 - Funding Innovation for Ag: Getting Tactical, Part 2 - Redeemable Equity
Last week I had the opportunity to speak at Verge about the Role for Redeemable Equity in Funding (Agri)Food Innovation. First, I set some context on the reality of the agtech financing landscape in an abbreviated overview of my “Barnyard Companies” breakdown (which I wrote about in greater depth in Cows & Chickens & Bivalves, Oh My: Funding Innovation for Agriculture and in Funding Innovation for Ag: Getting Tactical, Part 1 - The Problem with VC.)
The TL;DR is:
Agtech has a valuation challenge. Exit valuations aren’t terribly high. The average exit size in 2022 was $122M.
Agtech has a timing challenge. It takes a longer time to build successful solutions for seasonal, distributed industries.
Agtech investors are overly reliant upon M&A. This too often has negative consequences for farm customers, as venture backed companies are incentivized to build for exits rather than for their customers.
Barnyard metaphors are a fun way to zhuzh up finance talk. (🐔<🐄 <🦄 but can 🐔=🐉 or 🐄=🐉 or 🦬=🦄? If that didn’t make sense to you, you should really read my earlier posts.)
We should design financing mechanisms to suit the needs of agtech solution providers instead of copy+pasting the instruments from other industries and trying to force agtech companies to fit the Silicion Valley mold.
As an investor, I understand why we’ve copy+pasted Silicon Valley style VC funding mechanisms into every startup. The economics of fund management are limiting. Most funds manage other people’s money, so those fund managers have to convince the controllers of much larger funds or family offices or corporate entities (aka limited partners aka LPs) to invest a subset of their assets into their funds. This is really hard to do. It’s harder if you’re not wealthy and harder still if you’re not networked in VC/LP/Family-office world. The more money that funds spend on management and fund expenses; the less money can be actively invested with startup companies creating (hopefully real) value. This opportunity cost incentivizes fund managers to streamline processes that cost money, including legal negotiations around term sheets and deal docs. (To be more accurate, most venture investors charge at least a portion of legal costs back to the startup in which they're investing, which is also mutually undesirable - I’d rather every startup I invest in spend 100% of my investment on core business needs than legal.)
Organizations like National Venture Capital Association (NVCA) draft standardized docs to help with this. Y-Combinator is well known for having riffed off of existing standards to design and open-sourced Simple Agreements for Future Equity, aka SAFEs, which were designed by investors to be a better fit for very early-stage startups. SAFEs have been transformative - they’ve made it easy for startups to set basic terms to bring in angel investors. You could spend a couple of weeks reading VC and tech blogs about the pros and cons of SAFEs. I’m not going to go into detail on that here, but spend a few minutes on VC Twitter (or X, I guess we’re calling it) for an infinite supply of loudly voiced opinions on the topic. Personally, I do believe that SAFEs have a real role to play in venture investing, and I’m a huge believer in open-sourcing resources such that the community can both benefit and build upon them.
I also believe that it’s past time for agriculture as an industry to create the proper instrument(s) for funding agricultural solutions that don’t fit the grow-a-quick-unicorn model. Financings historically exist to align shareholders, all too often at the expense of stakeholders (most notably, the people who actually do the work to feed the world, aka users and customers.) I think we can do better. I think we can align stakeholders with shareholders. I think redeemable equity is an awesome start, particularly in the context of next generation ag equipment companies (aka robots.)
What is redeemable equity?
On a high level, it’s an equity-based financing instrument that incorporates debt elements. The company receiving investment has the opportunity to buy back a majority of the investors’ shares over time. So, for a completely theoretical example, if A invests $1M in exchange for 10% of B’s company, A and B agree in the term sheet upon a fixed return multiple on repayment, a repayment plan tied to a percentage of total revenues (or profits), and a fixed residual equity amount. So, maybe A and B agree that once B’s company reaches revenues in excess of $1M, they’ll begin to repay A quarterly with 5% of total revenues, until they’ve repaid $5M (a 5x multiple.) They agree that A will retain 2% ownership in the company even after redemption. Consequently, A gets paid back, faster and more probably, and B suffers less dilution in their company. As they mature, B can, if they wish, raise more funding through less expensive means given the company’s progress, or, if they wish, they can maintain a profitable and private company. B keeps their options open in a way that they don’t with purely equity financing. A can recycle (reinvest) the capital or distribute it to their LPs (investors in the fund) so that the LPs can invest in the next fund. This general dynamic will reduce the current reliance upon M&A in agtech, and will enable agtech VC funds to drive more reliable DPI and IRR for their investors. Win-win!
There are, of course, trade-offs. 2-5x returns are base hits, to blend baseball and VC jargon. In a world where most top quartile venture funds adhere strictly to a Power Law philosophy, or the idea that each individual investment must have the potential to return the entire fund, blending this into a venture portfolio is rather “contrarian.” That said, being “contrarian” is also cited as the key to outperformance in venture, so maybe those things cancel each other out?
There are a number of funds that have experimented successfully with alternative funding structures. Indie.vc is perhaps the best known - they went on a hiatus, but they’re back! In fact, they announced their first Indie Fund I investment this morning in their newsletter, and they very much downplayed the redeemable equity side of the equation, citing a common misunderstanding that redeemable equity meant that Indie was only seeking “lifestyle” businesses. Fellow investment mechanism pioneers (not in redeemable equity, but with shared earnings agreements, whole different can of worms) at Calm Fund empathized with this concern in this twitter/X-thread.
If you want to dive deeper, the Innovative Financing Playbook is, I think, the best resource out there tracking, you guessed it, innovative financing mechanisms. They’ve got a meaty page wholly dedicated to the pros and cons of the Redeemable Equity, as well as several sets of open-sourced redeemable equity term sheets and deal docs out there. If you’re a startup founder and you want to better understand what funding is right for you, Village Capital recently launched the Abaca App, which is a really cool tool to play around with to understand your options. There are a number of funds actively investing via redeemable equity, including:
Farmhand Ventures! (reply to this email to get in touch - our web presence is intentionally limited right now)
What do you think? Who else needs to be at the table in these conversations? Who else is investing in cool, weird ways in other industries that we can learn from? If you want to collaborate with Farmhand and friends to expand “venture capital” to better suit agriculture’s needs, hit reply. Constructive feedback is always welcome, too.
Please say hello if we’ll be in the same place this month. I’m in the Lou for another week, then I’ll be in…
Atlanta - Nov 14-15 for Women Transforming Food & Finance. I’ll be speaking about, you guessed it, alternative financing mechanisms for agrifood with THE Gina (Asoudegan) Nagel (truly one of the most legit humans in regen ag - I rarely get starstruck 🤩, but I am pretty stoked to be on a panel with Gina.) Come to listen to her spit wisdom.
Miami - Nov 16-18 for Culture Shifting Summit Miami - I’ll be speaking about agrifood investing trends alongside Karen LeVert, Managing Partner at LeVert Ventures and Rini Greenfield, Founding Managing Partner at Rethink Food, another set of rockstars in agrifood VC.
NJ/NYC - Nov 19-25 for Thanksgiving holidays. I’ll be working from the NJ burbs or my sister’s place in BK. Wednesday and Thursday are off limits, but I’ll be in and out of the city the rest of the week.