Seizing opportunities amid the agtech capital drought

(9 pages)

As the agriculture technology (agtech) industry adapts to a new normal in fundraising—and a vastly different macroeconomic climate than in years past—investment opportunities are slowly starting to emerge. Instead of waiting on the sidelines for conditions to stabilize, strategic companies and financial investors can use this limited window of opportunity to make bold moves and gain a competitive advantage.

Over the past few years, the agtech industry has faced a major capital drought. Venture capital (VC) funding has declined by 60 percent since late 2021, due to broader market uncertainty and decreased risk appetite among investors.¹ Although the funding environment is showing signs of stabilization, the impact of the slowdown on agtech start-ups, in particular, was significant. We estimate that approximately $6 billion that was invested in 30 important agtech start-ups was lost in 2023 because of turnaround or distress situations.² And several companies could face a similar fate: in our analyses of 349 well-funded start-ups, we have found that at least 30 percent of them, which are raising $10 billion to $15 billion in aggregate capital, are running behind on their fundraising targets and will likely need a capital injection.³

An investor’s perspective

Advances in agriculture technology (agtech) are fueling a wave of innovation. One such example is cellular agriculture, which uses biotech to produce agricultural products such as meat, seafood, dairy, and eggs directly from cells and single-celled organisms. Amid a rising global population, alternative proteins, including lab-grown cultivated meat, are fast gaining in popularity as carbon-neutral food production strategies that can help improve food security.

McKinsey’s John Levene spoke to Anthony Chow, cofounder of Agronomics, a London-listed venture capital firm focusing on cellular agriculture, about investor interest in emerging agtech and how companies are navigating the ongoing funding challenges.

McKinsey: What role do you believe cellular agriculture can play in the global transition to a net-zero economy? And how have investor profiles in the space evolved over the past few years?

Anthony Chow: An absolutely central role. It is the only technology with the potential to increase our food output while decreasing the resource intensity and greenhouse gas emissions associated with its production. We must face the reality that we simply cannot continue to feed today’s population of eight billion people with current consumption patterns and production methods, let alone the additional two billion people who will be on the planet in the coming decades.

We made our first investment in cellular agriculture back in 2018. At that point, there were about 20 companies in the field and only $50 million had gone into the sector globally. The investors supporting the industry back then were mission-driven investors with a heavy focus on animal welfare. Since 2018, we have seen a transition to far more sophisticated institutional investors, including sovereign-wealth funds, financial actors, and strategic investors.

McKinsey: How has the ongoing slowdown in overall venture capital and agtech investment affected the sector?

Anthony Chow: The last 18 months have been extremely challenging, not just for the field of cellular agriculture, but for public and private funding markets alike. The funding rounds that have been the hardest to get done are those of material size (above $30 million), because this is where you need participation from sophisticated institutional investors. Lofty valuation expectations from founders have now come down. As a result, after summer 2023, we started to see the purse strings of significant investors loosen, with funding rounds of stronger companies coming together.

This renewed financial discipline for all companies with the cost of capital increasing is healthy and has made founders and management teams focus on what is really going to create value and allow these companies to raise their next funding rounds. But in most cases, it has removed the prospect of multi-hundred million dollar Series B and C funding rounds.

McKinsey: What are some of the most common challenges that cellular-agriculture companies are facing in the current environment?

Anthony Chow: We know that cellular agriculture as a technology works and that it is possible to produce proteins using this technology. The challenge for these companies is whether the technology can produce them at an industrial scale and at a price point that is ultimately equal to or cheaper than that of conventional production methods. This is not an insignificant challenge, and access to capital is currently constraining the industry.

At a more granular and scientific level, the performance of the cell lines is the biggest factor in unit economics for cultivated-meat companies. I’m generally talking about three important metrics: doubling time, the time it takes the cell populations to double; densities, the density that the cells can grow to in the bioreactors; and differentiation, the time it takes the stem cells to differentiate into the specialized somatic cells, muscle, and fat.

For precision fermentation¹ companies, the challenge is the growth rate of the organisms and the titer that these organisms can achieve in a given time frame. Once high titers have been achieved, the challenge is the recovery rate of downstream processing, which varies substantially between expression systems. But as is the case for both cultivated meat and position fermentation, doing things at a very large scale is going to make a dramatic difference to the unit economics of the final product.

McKinsey: How do you expect the market to change over the next six to 12 months?

Anthony Chow: Investors have already begun to adjust back to what was the normal, traditional market—following an era of record-low interest rates—where there is a cost of capital and greater clarity on the interest rate hiking cycle. I don’t expect to see a return to an environment like 2021 for a very long time, if ever, but we are beginning to see larger funding rounds come together for the stronger companies in the field. The scheduled funding rounds, a further 18 to 24 months’ worth of technical progress, and cost reduction, along with regulatory approvals and the opening of additional jurisdictions to cultivated meats and precision fermentation, should be more than sufficient to generate excitement, which will lead to further funding flowing into the sector.

Anthony Chow is cofounder of Agronomics. John Levene is a partner in McKinsey’s New Jersey office.

Comments and opinions expressed by interviewees are their own and do not represent or reflect the opinions, policies, or positions of McKinsey & Company or have its endorsement.

Despite these headwinds, the long-term industry outlook remains promising. All the factors that made investment in agtech appealing in the past remain pertinent today: food security and sustainability concerns are top of mind for policy makers and consumers, and advancements in technology, particularly in digital and biotech, are helping agtech businesses become more profitable, productive, efficient, and environmentally friendly (see sidebar “An investor’s perspective”). Moreover, even though several start-ups are facing financing challenges, they continue to demonstrate that they have strong intellectual properties (IPs) and talent, often alongside novel business models.

Tough times can present unique opportunities, and this holds true for the agtech industry. In our view, there are several different plays on the table for strategic companies and financial investors to consider in the current environment, ranging from bolt-on acquisitions to direct minority investments, as we will highlight in this article.

Impact of the capital drought

In 2022, we examined how a sharp drop-off in funding affected agtech start-ups after we witnessed rapid growth between 2012 and 2020.⁴ How agtech start-ups can survive a capital drought,” McKinsey, November 10, 2022. The challenges persisted into 2023, with the sector experiencing a year-over-year decline of 30 percent in VC funding (Exhibit 1). The slowdown occurred against the backdrop of a broader retreat in overall VC investment, which fell by 50 percent over the same period.

There are several reasons why this is happening. Inflationary pressures have resulted in increased costs for essential resources such as energy, labor, and raw materials, creating sustained uncertainty about the long-term profitability and scaling potential of these start-ups and slowing down innovation. As a result, many start-ups are struggling with weak unit economics—a retreat from the “growth at all costs” business model—disappointing sales (for example, in plant-based protein), and long development cycles.

In this environment, institutional investors have become increasingly wary of expanding their private equity (PE) and VC exposure in agtech start-ups because of the fall in the equity value of their investments and lackluster performance. Higher interest rates have also made it costlier for them to provide funding for start-ups, while simultaneously increasing the risk-free rate of return.

Investors’ expectations for agtech start-ups have shifted over time, too. When the going was good, investors focused on companies that demonstrated strong growth. However, in a more challenged macroenvironment, they have increased emphasis on positive cash flow generation.

This trend in private agtech funding is also being mirrored on the public side. While this data is often overlooked in the broader assessment of the VC funding environment, our composite analysis of 35 public companies in third quarter 2023 showed a decline in market cap of around 60 percent from the peak of first quarter 2021.⁵

Venture capital funding in agriculture technology fell 30 percent in 2023.

The impact of this capital drought has been significant. We estimate that approximately $6 billion that was invested in 30 important agtech start-ups was at risk, if not already lost, as of June 2023. There are several reasons for this, including bankruptcy announcements, shutdowns, restructuring, and acquisitions. All five agtech subsectors we analyzed (next-gen foods and alternative proteins, controlled-environment agriculture, digital and precision agriculture, biosustainable materials, and sustainable inputs) faced various challenges, ranging from layoffs to bankruptcies, in both pre-IPO and public agtech companies (Exhibit 2).

Beyond the impact in pure dollar terms, the loss of talent across these 30 companies totaled over 3,300 individuals. And there is still the risk that the mature IPs, technologies, and assets owned by these start-ups could be erased if they are not meaningfully redeployed.

As a result of the agriculture technology capital drought, nearly $6 billion worth of investments are at risk of being lost.

To understand how many other agtech companies might be facing financing risk, we examined the elapsed time since the last funding rounds of 349 pre-IPO agtech start-ups and how it compared with the average duration between funding rounds over the past decade.

Notwithstanding the moves start-ups have taken to extend their runways, we believe this data provides an approximate indicator for the level of stress. Based on this research, we estimate that 30 percent of these start-ups are seeking their next funding round and will likely need a capital injection soon to remain operational (Exhibit 3). The aggregated capital they raised is estimated at between $10 billion and $15 billion. Without further investment, this capital could be lost, along with the IPs and talent they have developed.

About 30 percent of start-ups likely need financing, with $10 billion to $15 billion in funding at stake.

The hardest-hit subsectors could be next-gen foods and alternative proteins, digital and precision agriculture, and controlled-environment agriculture (Exhibit 4). Several start-ups in these subsectors have stretched their runways beyond initial expectations and are likely in need of additional funding.

Next-generation food start-ups are hardest hit by funding woes.

Reasons for optimism but a narrow window to act

These funding challenges and the potential loss of capital might prompt some to sound the death knell for the agtech industry, but in reality, its long-term outlook continues to look promising.

Let’s start by examining the funding decline in historical context. When analyzed over a ten-year period, agtech funding continues to remain robust, despite ongoing challenges. Funding data also shows early signs of stabilization after the COVID-19-pandemic-induced peak in 2021: the $4.6 billion invested in agtech start-ups between first and third quarters 2023 is, in fact, slightly higher than the $4.4 billion invested during the same period in 2020.⁶ This suggests that funding hasn’t dried up entirely for agtech start-ups. While aggregate funding is indeed lower than the 2021 peak, start-ups with growth potential are still able to attract investors.

Moreover, despite current macroeconomic challenges, there are several tailwinds powering the long-term growth of the sector. The agriculture industry benefits from digitization and the adoption of advanced technologies, including robotics, biotech, and generative AI. Potential end users also remain motivated to explore these new technologies, particularly as they become more affordable. At the same time, food security is a top geopolitical priority. With the agriculture industry responsible for over a quarter of emissions, sustainability remains a major problem.⁷Reducing agriculture emissions through improved farming practices, McKinsey, May 6, 2020. Upstream, we see bigger farms planning to increase their use of sustainable, digital, and precision agtech solutions.⁸ And further downstream, there is fast-growing adoption of flexitarian (semi-vegetarian) diets, especially among the more affluent and urban populations.⁹

Given these long-term growth factors, now is the time to play offense. In our view, incumbents and investors have a short window to act and provide financial or operational support to the start-ups that face funding challenges, while their capital still retains high value. Doing so proactively, while the IPs are still fresh and top talent is still around, can help investors retain and solidify the long-term value of these start-ups.

Strategies for investors and incumbents

Despite numerous challenges, including crop input inventory issues, incumbents have navigated industry disruptions and are therefore in a strong financial position to capitalize on investment opportunities. Based on our analysis, free cash flow¹⁰ among large agrifood incumbents, for example—especially in the growers, inputs, and food ingredient categories—grew at a CAGR of 10 percent between 2019 and 2022, which suggests they have capital available to deploy.

Meanwhile, investors, particularly those with cleantech agendas, still have considerable funds at their disposal. Climate tech investment in PE increased by 100 percent to $3 billion between 2021 and 2022; investment increased in VC by 10 percent to $10 billion during the same period.¹¹ The investor pool is also expanding: in recent years, there has been an influx of non-VC investors (such as growth equity and infrastructure investors) in the climate tech sector, which partially overlaps with the agrifood industry.

Below are four potential approaches that provide an array of risk/return trade-offs while addressing the underlying challenges at these start-ups:

Asserting operational discipline. The sudden and stark change in the funding environment has been a wake-up call for start-ups. As start-ups recalibrate their strategies, traditional PE investors can use this period to instill greater focus and discipline (ideally tied to tangible performance milestones, such as unit economics targets or enrolled acreage).
Distressed investment. We often observe that start-ups, especially in digital and precision agriculture, have compelling products but struggle with monetization because of user behavior or value chain challenges. There are instances when companies have run out of runway, but it is possible to relatively quickly fine-tune the offering and pivot the business and pricing models to create a quick-win opportunity.
Roll-up plays. Many agtech start-ups face issues regarding product competitiveness: products may lack in performance or cost competitiveness, leading to lower market traction. Alternative-protein companies, for example, must address multiple challenges at once: taste, affordability, and commercialization (including branding and distribution). A sequence of acquisitions of companies that have checked one or two (but not all) of the boxes could create a whole greater than the sum of its parts.
Partnerships. Recent interest rate hikes (and higher cost of capital) have challenged many business cases, particularly in areas with long development timelines, such as sustainable inputs and biomaterials. By providing cash injections and offtake agreements, strategic partners can prolong the runway and derisk their investments.

Strategies for start-ups

On their part, agtech start-ups can also make strategic and operational changes to their business models to navigate these challenging times. While the tailwinds discussed in this article should give them hope, they must also recognize and respond to the return to normalcy in the funding environment.

The reduction of burn rates remains paramount. We have seen different companies adopt this focus in line with their own industry contexts. Sustainable-inputs companies, for instance, are weighing the breadth of their R&D pipelines, recognizing that it is possible to “prove the platform” with a smaller number of new products than they may ultimately be capable of producing. Other options include the use of partnerships or a future owner’s own sales representatives to tap into new geographies. Meanwhile, established (but nonstrategic) business lines can be monetized through divestitures or licensing arrangements to bring in capital.

Start-ups can also look into whether vertical integration is a “must do” to commercially derisk the business or a “nice to have.” In the food and ingredients space, for example, we have observed a narrowing of business models, with some companies curtailing B2C food product ventures to focus purely on B2B ingredient plays.

The agtech industry remains as relevant as ever. While the uncertain global investment climate has made investors more cautious about their next moves, seizing innovative opportunities today may be essential to unlocking growth.