Why Venture Capital Likes Modular Farming

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Wharton's Sherryl Kuhlman and Joey Hundert, CEO of Sustainitech, discuss why modular farming has become a hotbed of VC interest.

Modular farming, which is growing crops in self-contained, movable units so they can thrive in difficult climates, is becoming more than just a sustainability goal for social impact organizations. It is also becoming a big business that’s increasingly being backed by venture capitalists and private equity firms. New startups in this market are sometimes models for not only how to make profits while contributing to the social good, but also how such profits can lead to innovation that goes on to create additional social good.

In this podcast interview, Sherryl Kuhlman, managing director of Wharton Social Impact Initiative (WSII), interviews Joey Hundert, founder and CEO of Sustainitech, about these developments and where the whole movement is heading.

An edited transcript of the conversation follows.

Sherryl Kuhlman: Tell us about Sustainitech.

Joey Hundert: Sustainitech produces indoor agriculture facilities in spaces. We build modular indoor farms to produce crops in places where it’s very hard to grow crops. So, think really harsh winters. Dry, arid regions. Really hot places. We build indoor farms, typically inside of shipping containers that can be put anywhere to grow crops successfully where it can be hard to grow them.

Kuhlman: Who are the clients and consumers?

Hundert: In Canada, we grow lettuces and fresh herbs. And the clients are the everyday consumer. We’ve partnered with food companies – and we grow on their behalf. We package up the produce, ship it to them, and they ship it to the consumer. And then one of our customers is actually an ethnic group in Manhattan that requires produce a specific way. And so, we grow the produce and ship it to them. And they ship it to people who eat it.

Kuhlman: What are the latest trends in indoor container farming?

Hundert: What I’m seeing is trends in indoor farming writ large. It has attracted a lot of capital to the space. The idea is unfortunately sexy. The reason I say that is I think it has whipped up a bit of a frenzy of interest in international media and in the capital markets. And it has chased a lot of money into the space. Now, you might say, “well that sounds great.” And I am happy about that. That’s not the part I don’t like.

It’s that there are unrealistic expectations of the companies in this space. I think some of the money is coming in from Silicon Valley, where there’s a belief that industries can be cornered, and that a winner-take-all approach can be had. But when it comes to fresh food and agriculture, it is a hopelessly [fractured] and diverse space for a reason. And so, I think some of the trends that I’m concerned about with the arrival of so much money is companies are trying to scale into the hundreds of millions.

Kuhlman: So that they can drive out the others.

Hundert: Pretty much. Which looks silly. But beyond that, I see core flaws in their technology — in their whole approach. And I just worry what happens when you hit carbon copy 300 million times on something. And I worry about what the failure of some of these larger startups is going to mean for the rest of the market. And so, we’ve been building our company while keeping in mind that this is happening in the market. And we’ve been offered — like most of our competitors — a lot of cash. We’ve been very conservative about what we will receive and what we will do with it, trying to build a more durable company that’s going to last until the market economics are proven. And that’s the real critique.

“I worry about what the failure of some of these larger startups is going to mean for the rest of the market.” –Joey Hundert

Kuhlman: Even here in Philadelphia, there’s a lot of interest in urban farming to adjust the food deserts. And the fresh and healthy food is nice to get from your neighborhood container farm rather than shipped from California.

Hundert: Local food is probably what drove the initial interest in indoor farming. However, the further you get into farming — especially in the most developed nations — if you look past the first few hands into the food system, you find a massive industrial-scale mechanized complex of farms and processors whose unit economics are amazingly low. We’re talking pennies per pound. If you take a New York City — a Manhattan-based urban farm — they need $5 to $10 per pound just to turn the lights on. And so, I’m worried that those farms that need 10 times the amount per unit are going to have trouble.

The industry has chased a few ideas. Firstly, the vertical approach from Japan. We’ve built vertical farms. I’ve built non-vertical farms. The non-vertical farms are much more capital-efficient than the vertical ones. If we were building in Hong Kong, I would totally go vertical. But the places in the world where you need to go vertical are not many.

And then the other piece is, everybody chased lettuce because lettuce and leafy greens grow so fast. But it has also created a flood of product, and still competing with the produce from the field and from the greenhouses is incredibly hard. So, I think those two things — vertical growth and chasing greens — have steered indoor agriculture companies after some unattainable goals.

Kuhlman: You’re talking about the financing around this — venture capital chasing this, pushing it. How else can an entrepreneur get the funding to make these ideas happen? For farming and for other kinds of initiatives?

Hundert: Silicon Valley has created the well-paved, smooth-running highway of capital available to technology-based ventures — globally, but certainly in North America. And that is nothing to complain about. It has made it much more affordable for ventures like mine to go after capital. The agreements are standardized. The investment tools are standardized. The lawyers know what they’re doing, and there are many, many investment shops. And that is super cool. So, I think that we’ve benefited from that. We’ll continue to benefit from it, and I’m glad it’s there.

But I also built my company differently. Indoor farming is a very high-capital cost industry. If I was to have sold equity from day one, I would have 3% in the company left. I would have been diluted right out of it. And so, we’ve found other ways of financing the company. The first thing we did was sell an entire indoor farm on contract. We found a buyer of a very specific kind of indoor farm, and we sold that farm. And that injected cash into the company. The first two, two-and-a-half years of the company were built on just that contract. And it did let me get into the game and really see what was going on.

Then we scored a contract to ship produce to a company. And you can finance contracts if you know what your cost of production is — if you know you can make money at it. It may be hard to go find a buyer of this produce, but is it any less hard than going and chasing capital when you have no value? I found it easier to go find a customer for the produce that was willing to pay a really high price for the quality. And we grew for three years on that. And so, we didn’t even open up our cap table until year five. And then we started raising equity capital with a valuation I could stomach. And I want entrepreneurs out there to know there’s other types of capital out there. Sometimes countries will fund technology companies to make sales in other countries.

Countries love export revenue. It’s awesome for GDP. And a lot of countries in the advanced world have a terrible imbalance in imports and exports. And so, there are funds available to assist in export of technology and crops. What I would have done differently — and what I encourage entrepreneurs to do — is to have gone to the major trade shows sooner to find out how specialized a lot of these buyers are and that you can get forward contracts on a lot of this stuff. It’s a different way of going about it, but I would rather build value and ultimately build more equity before approaching a VC, especially in a high-capital expenditure business.

“I would rather build value and ultimately build more equity before approaching VC, especially in a high-capital expenditure business.” –Joey Hundert

Kuhlman: A lot of the student entrepreneurs we’re seeing — and even ones we’re reading about — they’re going after the venture capital right away. They’re thinking it’s a long shot, but if you get that quick hit, you’re set.

Hundert: One of our competitors raised $128 million a month and a half ago in a Series B. There was a competitor last year that raised $200 million in a Series D. What life was like before that round and after that kind of a round — that is a way-different existence. And again, if the unit economics were there, great. But I think entrepreneurs have to ask themselves, what are they in it for? When you become instantly corporate, you’ll have a board filled with very serious people and specific goals and KPIs, that if you don’t hit, you won’t have much time to mess around when there’s a couple hundred million at play.

Whereas, at $20 million to $60 million at play, I think there’s more flexibility to go after more profitable ends and niches in the market. It’s a global market: Agriculture — fresh produce is a massive [market]. And you can even process the produce — making it into essential oil, a tea, a dried herb or a nutraceutical. It opens up global markets. And so, the further I’ve gone, the more happy I am with the choice not to play in the commodities of these farms.

Kuhlman: You’ve been visiting us as the Nazarian Social Innovator in Residence. This year it’s official, but you’ve been with us for seven times, right? … We’ve seen your development along the way. You like to make improvements. I could see why you would say, “I’d rather have the freedom to continue to change, explore and develop rather than get the money that forces me to scale in ways that I’m not comfortable with,” right?

Hundert: Exactly right. If I had an opportunity a year ago to take on lots of capital and scale massively — if I had scaled with those ideas, I’m sure we could have pulled out the win, of some kind. What we broke through to, technically, in the last nine months — even the last six months — is amazing. And I can head after those opportunities now.

We’re already writing contracts on them. The margins eclipse that which we were doing before. It also embeds more of a purpose piece in what we were doing. It has continued to change the nature of the company. And we’re in the millions. It’s not like there are small opportunities. It’s that if I, like some of my competitors, had just scaled what I was doing a year ago, I wouldn’t be anywhere near as confident as I am today that the profitability is really there.

Kuhlman: And that gives you a great deal of flexibility in thinking about what you’re going to do next, who you’re going to approach, and how you’re going to structure your next rounds.

Hundert: Absolutely right. And it changes the type of investors that we’re approaching and making sure that we’re as exciting to those investors as we’ve ever been. But if anything, our investors are feeding back that they get confident the more clarity with which we’re seeing the global market.

Kuhlman: What kinds of trends are you seeing in investors? I know you’ve funded your first initiative — the Sustainival, the carnival — through more traditional nonprofit grants and sponsorships. How are you seeing that transition going? Is there more blended capital? More venture capital?

Hundert: I would say that venture capital is incredibly mature at this point. It’s also a great time to be raising money. A lot of these funds are flush. Sure, there’s concern about a coming recession. However, there are funds that have just closed their rounds. They have three and four and five years of dry powder to spend. So, I’m seeing lots of capital. I’m seeing new private equity shops pop up every day that I didn’t know about. A lot of them are getting even more purpose-built —  for food, for robotics, for tech, for pharmaceuticals. Or even the venture arms of big corporations. They’re going at a purpose. And they’ve got these sidecar funds of $50 million or $100 million to go after a purpose.

“I’m seeing new private equity shops pop up every day that I didn’t know about.” –Joey Hundert

The ecosystem is so differentiated and flush. But beyond that, I think that some investors are wary of the companies that say, “we’re going to lose money for 15 years, and you’re going to need to pour in $10 billion, but then, we are going to boil the ocean.” I am seeing some skepticism about that now. There’s no question that some of these unicorns have blitz-scaled to the $50 billion mark. And everybody looks at Uber and looks at Airbnb and looks at Amazon, and says, “See?”

Kuhlman: You can do it.

Hundert: Right. But what about the 30,000 ventures that didn’t get anywhere close to that? What’s wrong with a 10x or a 30x? Why does it have to be a 700x? I’m seeing some skepticism in the capital markets about companies that say, “what we’re tackling is so huge and fundamental for society, someday we’re going to make money. Just bet on us and keep betting on us.” I’m seeing the preference for some investors to see some business savvy along the way. Can you cash-flow the venture? Is it profitable? When are you going to reach profitability? Can you do it a bit sooner? Can you access traditional bank financing? These are questions that we are being asked, and something that I’ve been seriously considering.

Because for a high-capital cost business, if I can get bank financing, that’s the cheapest non-dilutive capital that I could ever hope for. So, I’ve been working with banks to start to line that up because every dollar I borrow for our systems is a dollar I didn’t have to raise through equity capital. So, I think that the height of “We’ll make money someday” is actually behind us. And I’m seeing more value consciousness among certain institutional VC shops.

Kuhlman: I like the point you made about purpose, and more entrepreneurs and investments going towards that. We have a radio show on SiriusXM — Dollars and Change — and we’ve been doing it for about five years. And one of the things that we continue to see — our hypothesis is that the more funding that can go towards these purpose companies, the more likely entrepreneurs are to think about that as an opportunity. It proves the concept that you can have a business that has a purpose — makes a positive social impact — and still make money. And if you show that that’s possible, I think that inspires more entrepreneurs to think about how to make that happen.

Hundert: I would agree.

Kuhlman: It’s more fun to solve problems like that, right?

Hundert: It is. I think it’s in the heart of people. When I come to Wharton, I always like to take to pulse on what I’m hearing around here. What’s clear is that the concept of impact investing itself has matured here. People are looking at Wharton and looking at WSII — they’re coming here for that. I’ve talked with a couple of dozen students that came here because of WSII. I didn’t used to hear that. And they came here to learn about impact investing. I’ve even heard students saying, “I’m going into X big firm — big banking, big consulting firm — and I want to take these methodologies with me. I want to promulgate these ideas inside of large global firms.” That’s exciting. Wharton is one of those schools where that can actually come from. And students can carry it into those industries.

I’m also hearing a lot about the desire to blend purpose into venture – but it’s more sophisticated than in the past. It’s more concrete. In our company, we’ve had purpose on our minds the entire time. And there’s that terrible tension between making the company work and float and staying with the purpose. And one needs the other. Sometimes, you prioritize one or the other. I admit, much of the last six years was just making this thing technically work so that I could, again, point back more directly at [the company’s] purpose — when we could afford it, but most importantly, when the purpose made money to focus more on it. And to me, that’s the most virtuous blend.

If you can get the purpose to make money and actually be inspiring from a profitability standpoint, that’s maximum, when one isn’t taking away from the other [but] I admit, that is very hard. And we’ve done things just for profitability while I’ve had some purpose on my mind. And this year, we’ve begun to redevelop those programs — and they’re global in nature. They’re big. It’s a big lift. But we’ve restarted those programs that have purpose and profitability baked right into them.

Kuhlman: What advice would you give to an entrepreneur in this exciting, innovative, flush time for them to think about how to be most successful?

Hundert: I would actually report on something I’ve seen here at Wharton which I’m inspired by. I’ve been coming for eight years. This year, I’m [finding more people who would] most likely be candidates for success in venture than I’ve heard in years past. Somewhere, somehow, feedback came back to the cohort of students here to “get more specific. Niche out. Pick a niche and pick a product that is specifically built for something.”

I used to come in here [and hear startup pitches like] “It’s the Uber for this,” “it’s the Airbnb for that.” While there was lots of passion and energy, that [lack of focus] would concern me because you cannot boil the ocean and make your way. This year, I’m hearing about B2B plays on the most obscure things: switches and SaaS services for categories I didn’t even know existed. How students are finding this within weeks and months — it tells me something has trained them to look at the problem more carefully, and to look deeper into the market to find real problems instead of reading Fast Company and being like, “I want to be like that.” I’m heartened to see this shift towards more specific, niche high-growth opportunities.

That’s my advice back to entrepreneurs that might listen to this. Pick a niche. Pick it carefully. You’re not expected to know [it’s the right one for you] right away. Go deeper into the field. Deeper into the market. Meet players at trade shows. Stay curious. Ask tons of questions. Eventually, those apertures of real peer opportunity are going to open up. And they may not have been visible to you in the beginning. They may even be totally uninteresting to the general population. But they could be super profitable — and easier to build a moat around, and easier to capitalize. I like that movement. I like the movement towards specificity — niche-based, high-profit opportunities — instead of trying to boil the ocean.

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