Is Indoor Farming Making A Comeback?

After a period marked by a decline in investments during 2022-2023, Indoor Farming seems to be making a comeback.

Author

Sepehr Achard
July 25, 2024

Good morning readers.

In today’s edition, we explore how indoor farming is experiencing a resurgence after a challenging period marked by a decline in investments from 2022 to 2023.

Reading Time: 10 to 12 minutes

Special thanks to Henry Gordon Smith, Glenn Behrman, Thea-Isabella Otto & Peter Tasgal for their valuable input! Check out their respective content here.

ANALYSIS
Examining the Shift in Investment Trends in Indoor Farming

As the indoor farming industry experiences a resurgence in significant projects and substantial funding, a crucial question arises: have companies learned from past mistakes? Observing the changes and improvements in their approaches and strategies provides insights into this evolving landscape. We asked the question to 4 experts, and here are their thoughts:

1- Emerging Markets and Global Expansion:

"Many recent large-scale project announcements are coming from newer companies outside the traditional core markets of the US and EU where the most significant investments and failures were previously observed," noted Henry Gordon Smith, CEO & Founder of Agritecture. "These emerging markets have not yet experienced the bubble burst, which explains part of this positive news."

2- Climate Change and Food Security:

"Climate change, increasing demand for quality food, and threats to supply chains continue to drive the growth of Controlled Environment Agriculture (CEA) and Vertical Farming (VF)," says Henry Gordon-Smith. Governments and municipalities increasingly prioritize agriculture and food production due to concerns over food security and local supply chains. Retailers struggling with imported produce and empty shelves seek local alternatives. Consultant Thea Otto remarks, "Food security and local supply chains have become more pressing issues in recent years and are now on the agenda of a wider array of stakeholders."

3- Historical Investment Patterns:

Peter Tasgal, a Food & Agriculture Consultant, explains that the peak of investment in the controlled environment agriculture (CEA) space in 2021 can be attributed to extremely low interest rates, reduced costs of LED lighting, and a robust investment environment, including the SPAC market. As interest rates began to rise in 2022 and SPAC performance worsened, investors' enthusiasm waned. However, in recent months, there has been a revival in investment. He adds, "Investors believe interest rates are peaking and should come down soon. Investors have historical performance as a basis for their investment, and more diligent investors are entering the space."

4- A Greater Focus on Proven Results:

The industry is shifting its focus towards companies that deliver proven results and successful benchmarks. Glenn Behrman, CEO of CEA Advisors, emphasizes the differences in progress between various companies. He notes, "Some companies that raised funds have slowly built a business with results; their funding and expansion are based on results and success in reaching key milestones. Nonetheless, some larger deals have yet to demonstrate significant achievements despite frequent announcements of upcoming progress.” Behrman states.

THE LEARNING CURVE
Learning from Past Mistakes: Evolving Strategies in Indoor Farming

1- Focus on Quality and Results

The quality of personnel and a focus on operational success have become critical factors in the evolving indoor farming industry. Glenn Behrman emphasizes this, saying, "I think that the quality of people that are getting involved with indoor farming today are much more committed, realistic, and sincere." Behrman notes that successful companies prioritize profitable operations over mere funding pursuits. "This shift towards a results-oriented mindset represents a significant evolution from earlier, more speculative phases of the industry," he remarks.

2- Mixed Lessons Learned

Despite the recent growth in the industry, skepticism remains about whether the lessons from past failures have been fully absorbed. Henry Gordon Smith, CEO & Founder of Agritecture, highlights this, stating, "More experienced professionals could help address operational challenges faced by earlier vertical farms." However, the persistence of issues like greenwashing indicates that the learning curve is still ongoing. Smith also notes, "Over 90% [of my network] believe that vertical farming hasn't yet learned from its past mistakes."

3- The Importance of Strategic Investment and Location

Peter Tasgal provides a more optimistic outlook, particularly regarding vertical farming. He believes that investors have learned from past errors, especially in recognizing the importance of location for profitability. "There needs to be a consumer who can afford to pay for premium products in a location where access to lower-priced premium products is unavailable," explains Tasgal.

4- Merging Technology and Practicality

A notable shift in the industry is the movement towards practical and relevant use of technology. Thea Otto highlights this trend: "We can see how technology that has been developed for the sake of technology is not succeeding." Otto emphasizes that successful companies focus on plant-centric and human-centric approaches. She also notes a trend among greenhouse growers towards self-sufficiency in seedling production, illustrating how vertical farming and the CEA industry can complement rather than compete with traditional agriculture.

EXTERNALITIES’ IMPACT
The Role of Accumulated Capital

Reports indicate that venture capitalists are sitting on an increasing pile of roughly $300 billion, and investors, in general, have accumulated more cash than ever before. This financial backdrop raises questions about its influence on the rise of project value and funding rounds in the indoor farming industry.

1- The Distinction Between Venture Capital & Private Equity

Peter Tasgal provides a nuanced view by distinguishing between venture capital and private equity. "I think there is always capital available for good deals. I would distinguish private equity vs venture capital," he explains. Venture capital typically involves high-risk investments with the expectation that a small number will yield significant returns. In contrast, private equity focuses on companies already producing cash flow or with a clear path. Tasgal predicts that, in the short term, there will be more private equity investments than venture capital. He adds, "The margins on most of the companies do not lend themselves to enormous returns, as a product is being grown," contrasting this with traditional technology investments where product costs may be negligible.

2- Acknowledging The Influence of Available Capital

Henry Gordon Smith acknowledges that the influx of available capital likely plays a role in the rise of large projects and funding rounds within the industry. "The increasing pile of venture capital and the accumulation of more cash by investors likely contribute to the rise of large projects and funding rounds in the industry," he notes. With more capital to spend, ESG-related initiatives like vertical farming should benefit, at least in the short term. However, Smith emphasizes that the industry needs to standardize, collaborate more effectively, and reduce greenwashing and hype for sustained growth.

3- Investors Demand for Proven Success

Glenn Behrman, Founder of CEA Advisors, acknowledges the significant venture capital available but expresses skepticism about its overall impact on the industry. "I think that the investment community has enough experience with indoor farming that they're waiting for somebody to be profitable, and they're waiting for somebody to be the poster boy for a successful investment," he remarks.

The Impact of Potential Interest Rate Cuts on the Indoor Farming Industry

As discussions around potential interest rate cuts in significant markets like North America and Europe gain traction, questions arise about their impact on investor confidence and the overall investment climate, particularly for high-capital expenditure (high-capex) projects.

1- Providing Reassurance and Accessibility To Large-Scale Projects

Henry Gordon Smith believes that potential interest rate cuts would likely reassure investors and stimulate more investment in large-scale projects. "Lower interest rates would make funding more accessible," Smith notes, emphasizing that this financial environment presents a valuable opportunity for the industry. However, he underscores the importance of using this opportunity wisely to avoid past mistakes. The potential for more accessible funding could help drive innovation and expansion within the sector, provided that investments are managed prudently.

2- Interest Rate Dynamics

Peter Tasgal offers a detailed view of the impact of interest rate dynamics. He highlights that many investors believe current rates are at their peak. "If a deal works in the current interest rate environment, it will get even better as rates improve," Tasgal explains. He points out that falling rates could also provide access to junior debt capital, such as mezzanine and hedge funds, which currently expect 10 to 12% returns for highly liquid investments. Lower rates might attract these junior capital funds back into the market, especially if there is a demonstrated history of success.

3- Shouldn’t Rely On Hopes Of Interest Rate Cuts

Glenn Behrman, Founder of CEA Advisors, acknowledges the evolving economic opportunities that potential interest rate cuts could bring. Behrman implies that while lower interest rates may reassure investors, the industry should not rely solely on these conditions for growth. Instead, a robust strategy that includes thorough vetting and prudent investment practices is essential for long-term success.

Investment Distribution in Indoor Farming: A Focus on Larger Companies

Examining the Distribution of Capital in the Industry

Despite the increased availability of capital, most of the money seems to flow to larger, more established companies within the indoor farming industry. This raises questions about whether this funding will eventually reach startups and smaller companies and what needs to happen for a more equitable distribution of investment across the industry.

1- Targeting Larger Companies

Henry Gordon Smith, CEO and founder of Agritecture, acknowledges that most investments are currently directed toward more prominent companies. "Large investments often demand scale that only bigger companies can provide," he explains. Smith suggests a multifaceted approach involving municipal support, grants, crowdfunding, and smaller project financing to shift this trend and allow funding to reach startups and smaller companies. He believes cities could play a crucial role by subsidizing smaller distributed farms with a meaningful community impact.

2- Investment Flow to Established Companies

Peter Tasgal, a Food & Agriculture Consultant, believes that in the short and medium term, most investments will continue to flow to larger companies capable of sustaining themselves during downtimes. "Once the market has developed further, and profitability has become highly evident, then you will see the return of more entrepreneurial activity to enhance larger businesses," Tasgal states. He suggests that smaller investment sizes with higher risk profiles will enter the market once the industry reaches a more mature and profitable stage.

3- Natural Progression of Investment

Thea Otto, a consultant, views the current investment trend as a natural progression. "Large-scale companies or further established start-ups are always raising for larger deal sizes than a small bootstrapped company. This is a very normal concept that won't change," she explains. She questions whether this represents an inequitable financing scheme, suggesting that the current investment distribution aligns with the typical development stages of technology and business growth.

4- Finding Funding Isn’t A Business Model

Glenn Behrman, Founder of CEA Advisors, expresses skepticism about the equitable investment distribution. "Right now, funding is not a business model, and back then it was," he observes. "You build a small successful business based on your real capabilities. And once you've achieved profitability, it may be time to go out and look for money," he advises.

Additional Resources

  • Check out the Agritecture Designer platform’s partner network here.

  • Discover Glenn Behrman’s CEA Advisors here.

  • Check out Henry’s newsletter, ‘The Agritect Chronicles,’ here.

  • Check out Thea’s organization, Women In CEA, here.

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