Warning: Select Your AgTech Partners Carefully!

Warning: Select your AgTech partners carefully!

I was in Chicago for an AgTech conference this week and I want to share some concerns with you.

At this conference there was a lot of talk about a potential bubble in the AgTech community. Here are my thoughts on the overall AgTech market.

• We’re going to see some amazing technology on the farm in the next few years. I’m particularly excited about technology that will allow farmers to reduce expenses, such as tech-enabled spot spraying.
• There are quite a few solutions seeking a problem rather than problems seeking a solution.
  
• One example of the above that I see is one-click variable rate prescriptions that use a combination of historical satellite imagery, soil maps, and/or yield maps. In an informal survey I completed recently of over 100 farmers, none of them said they were willing to spend $5-10/acre for algorithm-generated VR scripts while 90% said they are willing to invest a similar amount in a good full service agronomy package. Producers still want boots on the ground was the consensus.
• My biggest concern is that a number of AgTech companies have raised too much capital for the size of their market. This leads to trouble. More below.

A bit of background is needed on venture capital. Most venture capitalists seek a 10x return on their investments when participating in new investment opportunities. Out of a portfolio of 10 investments, they’d expect to hit a couple 10x (or more) home runs with a couple small positive returns.

Oftentimes the majority of businesses in a venture capitalist’s portfolio will fail. And this is actually the expected outcome for most venture capital firms!

Many VC’s expect more than 50% of their investments to fail. What if your AgTech partner is one of them!?

I really don’t like alarmists and I know I’m starting to sound like one here. But I do like math. Let’s look at a simple example.

Let’s assume an AgTech startup raises $20 million dollars in venture capital by selling a 50% stake in their business. This capital will likely be in the form of a debt-like instrument that can be converted to equity if the company is successful. In layman’s terms, even though the venture capitalists only own a 50% stake they will receive 100% of the proceeds of a sale less than $20 million.

Over its first 3-4 years, lets assume this venture-backed startup grows to $6 million in revenue and $2 million in profits but growth starts to stall. No growth is the enemy of venture-backed startups.

This level of revenue and profitability would be higher than most of the businesses in the US/Canada. Great, right?! Not so much…..

This is my educated opinion on how it would likely play out.

1. The company’s board of directors stresses the need to grow in order to achieve a favorable exit. They need a $100+ million exit and the business I described above is likely worth $10-15 million.
2. The company’s management decides to invest their profits in a variety of new strategies.
3. In order to chase growth, they are now burning capital and operating at a loss.
4. Everyone in the business starts to realize that the company is worth less then the $20 million of venture capital “debt” on the balance sheet, leaving their stock and options worthless. This is where things go bad….
5. You as a user start to notice management changes and employee turnover.
6. If the company isn’t able to find a new growth channel it’s likely that they’ll have to sell at a price that yields the employees zero for their stock/options or they simply shut the business down.

Based on my experience in private equity, as soon as employees deem their stock or options as worthless the business is in trouble.

If you can’t tell by now, I am a bit biased against venture capital. If you have a proven business model or have a need for large expensive hardware investments (see this cool business called Blue River Technologies), then venture capital is a great way to grow and fund product improvements.

If you have a proven, scalable, and profitable business model you’d be foolish not to seek investment to accelerate your growth. If you aren’t there yet, raising capital likely won’t help and often leads to the broken balance sheet scenario I’ve described above.

My personal opinion is that a farm software business should be funded by its customers, at least initially until the business model is proven. That is what we are doing at Harvest Profit.

Could we use more capital to push out features faster? Hell yes! But we’re willing to move a little slow to ensure that we’re going to be around to service our users who’ve entrusted us with their business.

I think it’s a very fair question for you to ask your AgTech partners if they are profitable or not. If they are not, proceed with caution.

In full transparency, Harvest Profit is running at a slight loss so far in 2018 but we will end the year close to breakeven. Our goal is to continue to invest nearly all of our revenue back into the product but we’re going to do so with the always present goal of being around for our customers over the long-term.

There are going to be some amazing technologies in farming over the next decade. But there will also be some failures.

Do some due diligence on your AgTech partners before you give them any of your hard-earned capital (us included).

Our primary goal is to help farmers make more profitable farm business decisions. Selecting your technology partners is one of these decisions.

As always, let us know if you have any thoughts or questions. We’d love to hear from you.