In Sun Tzu’s The Art of War, the author suggests that “in the midst of chaos, there is also opportunity.” The CEA industry, especially vertical farms, is in chaos, creating a fantastic opportunity to learn from past failures, set realistic expectations, and develop new business models with a laser focus. This article answers the following questions:
- Why has a public opinion/investor interest soured on vertical farming?
- What kind of CEA company are you?
- What is a sustainable business model?
- What are possible sources of capital to fund CEA startups?
As a pioneer in CEA, with over a decade of experience in the vertical farm industry as an investor, technology innovator, farm builder, and operator, I have cuts and bruises from learning what doesn’t work. Constantly searching for better ways to make vertical farms more efficient and profitable, this article was written to share my candid perspective on what needs to change to make the industry viable.
Controlled Environment Agriculture is the science of growing crops in a protective indoor environment to extend the growing season and increase crop quality and yield. Two major cultivation formats are used to grow crops indoors – a greenhouse or a vertical farm. Various cultivation methods are used to grow crops, with hydroponics being the most prevalent, as shown in the illustration below.
Over the last few years, vertical farms and greenhouses have been lumped together when talking about CEA since they are both methods of indoor growing. In practice, each has a different business cycle and is best at growing different crops. This article primarily focuses on vertical farms.
Vertical farming, like any emerging industry, has certain perceptions associated with it. Some are valid concerns; others are unrealistic expectations from false promotions or media hype. The recent failure, bankruptcies, or downsizing of several well-capitalized vertical farm companies, such as Aerofarms, Agricool, Fifth Season, InFarm, Iron OX, and Kalera… has tainted the perception of the CEA industry for both investors and the public.
The following points, in my opinion, represent the key concerns with vertical farms:
- High Initial Investment: Vertical farming requires significant upfront investment in infrastructure, technology, and operational costs. This can create a perception that vertical farming is only viable for large-scale operations or well-funded companies, potentially excluding smaller or resource-constrained farmers. This high upfront cost has attracted VC investors who like to invest large sums of capital as they say it’s easier to raise $100M than $1M.
- Limited Scale and Crop Variety: Vertical farming is often associated with growing leafy greens and herbs due to their quick growth cycle and turnover, which helps control pests. The limited variety of crops grown in vertical farms compared to field farms or greenhouses lacks agricultural diversity. As seed companies develop genetics designed to grow indoors under LED lights, this will change.
- Energy Consumption: Vertical farms rely on artificial lighting (LED lights), climate control systems, and other technologies that consume much electricity. This increases the cost to build and operate farms and can be perceived to offset the environmental benefits and contribute to higher carbon emissions. As the industry moves forward, it must build more energy-efficient farms and second use renewable energy sources to lower operating costs and greenhouse gas emissions.
- Questions of Economic Viability: The economic viability of vertical farming, especially at a large scale, has not been proven to date. Based on my analysis of 5 well-capitalized vertical farms, we found that the unit production cost does not decrease as the size of a farm increases. This is counterintuitive and begs the question, what is the right size to build a farm so that it is profitable? The next phase of vertical farms will be smaller modular farms with mono-crop grow rooms that can be scaled to meet demand.
- Limited Adoption and Scalability: While vertical farming has gained attention and investment, it is still not as widespread as field farms and greenhouses. Skepticism may arise from concerns about the scalability and the ability to feed larger populations using vertical farming as a primary food production method. The critical attribute of a vertical farm is that it can grow a higher density for the crop in a smaller footprint. A distributive farming model will evolve that disrupts distribution putting smaller farms at or near the consumer.
It’s important to note that many of these perceptions are based on startups’ early-stage challenges and a lack of a proven track record. As the industry continues to evolve, address these concerns, and demonstrate its potential benefits, such as reduced water usage, year-round crop production, local food production, and minimal pesticide use, and demonstrate that farms can produce a consistent supply of high-quality products at a profit, the negative image associated with vertical farming will dissipate.
What Kind of CEA Company?
Many well-capitalized failed companies tried to be many things, but when you try to be everything, you end up being good at nothing. Companies were part farm operator, builder, and Ag Tech company. Each of these types of companies has a different profit margin and customer base and is best suited for a different source of capital. Pick an area and be the best!
- Farm Operator: A grower operator is an individual or a company that directly engages in cultivating and managing crops or agricultural products. They are responsible for the farm’s day-to-day operations, including planting, nurturing, and harvesting crops. Grower operators may have expertise in agronomy, horticulture, or specialized crop cultivation techniques. They are involved in implementing farming practices, managing resources such as water, nutrients, and pest control, and ensuring optimal crop growth and quality. Grower operators may utilize Ag Tech solutions or work with farm builders to enhance their farming operations and improve efficiency. They are primarily focused on the actual cultivation and production of crops and may also be involved in the marketing and selling of their agricultural products.
- Farm Builder: A farm builder is a company or entity that specializes in constructing and setting up CEA facilities, including greenhouses and vertical farms. Their expertise lies in designing, procuring equipment, constructing the physical infrastructure, and installing it. Farm builders may work closely with agricultural experts, engineers, architects, and contractors to develop and implement customized farming facilities. They focus on creating functional and efficient spaces that optimize layout, lighting, temperature control, irrigation systems, and other critical elements to support crop cultivation. Farm builders may collaborate with growers/Operators, investors, or Ag Tech companies to ensure that the CEA facility meets the specific needs and requirements of the client.
- Ag Tech Company: An Ag Tech (agricultural technology) company is focused on developing and providing innovative technologies, products, or services to improve and enhance various aspects of agriculture. They may specialize in developing hardware, software, or both, to address challenges in farming practices, crop cultivation, resource management, data analytics, automation, or other areas of agricultural operations. Ag Tech companies aim to bring technological advancements to the agriculture industry to increase efficiency, productivity, sustainability, and profitability. They often collaborate with farmers, researchers, and other stakeholders to develop and implement their solutions.
Agriculture is a unique business requiring traditional business administration skills and the expertise required to manufacture a perishable, biological product on a schedule consistently. It takes years to perfect SOPs and growing operations to produce consistent, high-quality produce at a competitive price and, most importantly, to build customer trust.
While an Ag Tech company focuses on developing and providing agricultural technologies and solutions, a farm builder specializes in constructing agricultural facilities, and a grower operator is primarily engaged in crop cultivation, farm management, and produce sales. These entities can often work together in the agriculture industry, with Ag Tech companies providing technology to farm builders and grower operators to enhance efficiency and productivity.
How do you define success for a vertical farm? There are different perspectives and definitions depending on who you ask:
- Academician: a farm that produces reliable, consistent data that is replicable.
- Operator: a farm that produces a consistent, high-quality crop that meets customer expectations.
- Investor: a farm that meets or exceeds a projected return on investment.
When the first vertical farms were built 15 years ago, success was measured by proof of concept. They proved that a commercial-scale indoor farm could be built to grow quality pest-free crops year-round.
In the last decade, we learned how to build indoor vertical farms that operate efficiently and are improving yearly. The definition of success is evolving to include having an experienced staff, proven SOPs, and a robust business/distribution model that allows vertical farms to operate profitably.
In my experience, the farms that have been profitable to date include smaller-size farms with the hyper-local distribution of a niche crop and a loyal local customer base. The farm owner works with a few employees, makes the initial capital investment, and may carry a small debt. They have no equity investors, no C-suite, and built their business the old fashion way – through hard work and bootstrapping.
The following are key elements to consider in creating a business model:
- Vertical Farming Operations: The core of the business model revolves around the vertical farming operations themselves. The focus is on producing a year-round supply of high-quality, pesticide-free, and locally grown crops, irrespective of seasonal and weather constraints. Developing strong distribution channels is crucial for being a profitable farm connecting with customers and delivering fresh produce efficiently and consistently day after day. This can involve direct sales to consumers through online platforms, partnerships with grocery stores, restaurants or local food cooperatives, or participation in farmers’ markets. Another innovative option is subscription-based models or community-supported agriculture (CSA) programs.
- Crop Selection: Identifying and selecting the right crops to grow is essential. High-value and high-demand crops such as leafy greens, herbs, microgreens, mushrooms, and other specialty vegetables can be good crops to consider for production. The selection should also consider market demand, customer preferences, packaging, distribution, and profitability.
- Technology & Sustainability: Vertical farms aim to maximize resource efficiency, including water, energy, and land which also promote sustainability. Emphasizing sustainability can also enhance the brand image and attract environmentally conscious consumers. Keeping up with advancements in technology and data analytics is essential for continuous improvement. Integration of sensors, automation, and data analytics allows for real-time monitoring of crop growth, resource utilization, and environmental conditions. This data-driven approach enables better decision-making, optimization of production processes, and improved crop yields.
At a minimum growing technology should include LED lighting, automated climate control systems, precise nutrient delivery systems, water treatment, nutrient recirculation system, and CO2 enrichment. The automated delivery of growing inputs will maximize crop production, optimize resource consumption, reduce waste, and lower operating costs. In addition, having the proper software and back-office systems to manage inventory, labor and invoicing will help to increase profitability.
- Partnerships and Collaboration: Indoor vertical farms can form partnerships or collaborations with other industry players, such as food manufacturers, retailers, or restaurants. These partnerships can lead to joint marketing efforts, product development, or supply chain integration, providing additional revenue streams and market opportunities.
- Education and Community Engagement: Educating consumers about the benefits of vertical farming and fostering community engagement can help build a loyal customer base. This can involve hosting farm dinners, educational workshops, organizing farm tours, or actively participating in community outreach programs. This is an area where vertical farm association can be of great assistance producing fact based objective credible information hat highlights the pros and cons of indoor farming.
It’s important to note that the specific elements of a successful business model may vary depending on factors such as the local market dynamics, target customer segment, and competitive landscape. Continuous adaptation, innovation, and responsiveness to market demands are crucial for long-term success in the vertical farming industry.
The capital sources available for funding indoor vertical farm startups can vary depending on the specific needs and circumstances of each company. VC funding has been the primary source of financing large-scale operations in the past; however, the decrease in VC funding has intensified challenges for indoor farming startups to find equity, as shown in the chart below. The chart shows that in Q1-22 a high of $895 M, and in Q2-23 a low of $9 M of VC funds was invested in indoor startups, resulting in a decline of approximately 99 percent.
As VCs are temporarily sidelined (until CEA companies begin to generate revenue and earnings) and rising interest rates have made debt financing expensive, startups will need to be creative to identify different sources of capital to fund operations. Below is a list in order of importance of the key sources of capital that can be used to fund startups:
- Revenue Generation: Indoor vertical farms can generate revenue through the sale of their produce. This can include direct sales to consumers, partnerships with grocery stores or restaurants, or participation in community-supported agriculture (CSA) programs. Sustainable revenue generation is crucial for the long-term viability of the business.
- Grants and Subsidies: Vertical farms may be eligible for grants or subsidies from government agencies, non-profit organizations, or research institutions. These funding sources can provide non-repayable funds to support specific aspects of the business, such as research and development, sustainable practices, or community initiatives.
- Government Programs and Incentives: Governments often offer programs and incentives to support the growth of the agricultural and sustainable farming sectors. These can include tax credits, research grants, subsidies for energy-efficient equipment, or incentives for job creation.
- Crowdfunding: Crowdfunding platforms allow companies to raise funds from many individuals who contribute small amounts. Vertical farms can leverage crowdfunding to engage with the public, gain exposure, and secure funding for specific projects or products.
- Strategic Partnerships: Partnering with larger agricultural or food-related companies can provide access to capital, expertise, and distribution networks. Strategic partnerships can take various forms, including joint ventures, licensing agreements, or supply chain collaborations. Such partnerships can provide both financial and non-financial support.
- Debt: Debt financing involves borrowing money that needs to be repaid with interest over a specified period. Vertical farms may seek debt financing from banks, financial institutions, or government-backed loan programs. Many municipalities have revolving loan programs that provide debt financing below market rates to startups. Debt can provide a more stable and predictable source of funding, but it also comes with the obligation to make regular interest and principal payments.
The optimal capital stack for a vertical farm company will depend on factors such as the company’s stage of development, the type of company, its specific business model, the market conditions, and the availability of different funding sources. Companies should carefully evaluate and tailor their capital stack to meet their unique needs and goals.
Different capital sources seek different rates or return. Farm operators typically have the least gross profit margins. Based on my experience, they can range between 5-20 percent. Profit margins can vary depending on several factors, including the types of crops grown, market conditions, operational efficiency, distribution model and management practices. Traditionally, these operations were self-funded, and used family and friends and bank debt to start operations. The low margins make them less attractive to VC financing unless they are part of a role-up strategy.
Farm builders have higher gross profit margins that can range from 10-30 percent. This variation is due to factors such as the size and complexity of projects, regional market conditions, competition, and the expertise and reputation of the builder.
AgTech companies encompass a wide range of technologies and solutions aimed at improving agricultural productivity, efficiency, and sustainability. This includes agriculture hardware and equipment companies, service-based AgTech companies (that provide consulting, agronomic advisory, and crop monitoring), and lastly software and analytics companies. Gross profit margins for AgTech companies can range between 20-80 percent. The gross profit margins of AgTech companies can vary significantly based on the specific products or services they offer, their business models, market conditions, and various other factors.
With both AgTech companies and Farm Builders having higher gross profit margins, they can be an attractive investment opportunity for a wide range of investors including both VC and institutional sources of debt.
Many profitable agriculture companies have evolved to be recognized brands, giving them purchasing power to buy inputs at a lower cost due to their size and economy of scale. They have also built fine-tuned operations over many years, which are optimized to lower their unit production costs. This allows them to sell produce at a competitive price while maintaining higher margins. Produce companies such as Dole, Mastronardi Produce, and Tanimura & Antle didn’t get big overnight, they started small, and gained market share over many years before receiving external investment. History indicates that placing large amounts of capital into a CEA startup does not guarantee success.
We have proven indoor vertical farms can grow produce indoors, the next phase is to build the right-size farm, create a successful business and distribution model, and build a customer base that allows for expansion as demand increases.
Farm builders and Ag Tech companies can also be a viable CEA business model. These companies will require farm operators as customers. With more smaller farms being built, there will be more customers in need of farm technology and builders.
CEA can be a viable solution for producing high quality produce at a competitive price if the industry can improve its image by cutting out the hype, accentuating the positive benefits such as reduced water usage, year-round crop production, local food production, minimal pesticide use, decrease energy consumption, and lower operating costs.
In the short term more indoor vertical farms will fail and consolidation will begin. Farm operators will begin to merge with other growers to offer a wider range of crops. Farm builders will partner with greenhouse builders and a variety of tech companies will form alliances with each other and with farm builders. As painful as this transition will be, it will also make for a stronger more reliable industry.
As vertical farms evolve, they can be disruptive to the produce distribution system, getting more money to the farmer and fresher high-quality competitively priced produce to the consumer.
Living in a period when immediate isn’t fast enough, we will also need one more precious resource…time!
On the lighter side, when things are changing, and you feel you can’t there from here!
About the Author
Robert Colangelo is the founder of CEA Technology, Inc., and is a pioneer in vertical farming and built the first indoor farm in 2010. He has built and operated vertical farms globally. He is cut and bruised by the CEA wars, but not broken.
CEA has developed and patented the modular, hybrid (greenhouse / vertical farm) that can scale to meet demand and has formed a joint venture with RUFEPA, a Spanish manufacturer and installer of greenhouses worldwide.
Image provided by CEA Technology