Monday, October 25, 2010

Of Haymakers and Rainmakers

“We should, I believe, be judged by our compromises more than by our ideals and our norms…Ideals may tell us something important about what we would like to be. But compromises tell us who we are.”

On Compromise and Rotten Compromises, by Avishai Margalit

Recently, I went to a panel discussion on urban agriculture at the Kellen Gallery, part of the Living Concrete/Carrot City exhibition. To anyone tuned into the food debate in the New York area, familiar sentiments were on display: scrappy entrepreneurs with a love for farming and/or eating, nurturing their holistic vision of a just society, itself replete with happy farmers tilling ever-healthier soil, which in turn produces nutritious fare for contented locavores, farmer’s-market enthusiasts, schoolkids, or [insert your constituency here], building greater community while lessening our carbon footprint, etc.

Being the happy curmudgeon, I was glad to sneak in the following during Q&A:

Aerofarm is a startup that is only a few years old. Their model does not have anything to do with creating community, or building soil health, or even encouraging food awareness or organic agriculture. They have developed technology that allows people to grow food in enclosed spaces, without sunlight, without soil, even. They recently received $500,000 in seed funding from several venture capital groups. Is there room for everyone to play in this space, or does Aerofarm, etc represent a threat to the vision of (urban) agriculture as implicitly envisioned by this panel and the food movement as we know it in general?”

It was disappointing to see the panel – or what takers there were – squirm their way through this question. One posited that “hydroponic agriculture” is a tremendous waste of resources. This may be or may not be true, but the fact is that Aerofarm is not a hydroponic operation. Another was concerned with the fact that Aerofarm was going to dilute the nascent “brand” of urban agriculture. No one really understood that my question was about money.

So what, exactly, does $500,000 “mean”? Let’s compare Aerofarm’s seed funding with the MacArthur Genius Grant, which itself is $500,000.

According to the MacArthur Foundation’s website, “MacArthur Fellows Program awards unrestricted fellowships to talented individuals who have shown extraordinary originality and dedication in their creative pursuits and a marked capacity for self-direction.” This essentially means that you have been busting your hump for a good chunk of your life before the Genius Grant smiles on you, eg: Will Allen, MacArthur 2008.

In fact, it was Cheryl Rogowski, not Allen, who was recognized as the first farmer-recipient by MacArthur, and that was in 2004. She has been farming since 1983. Wags might point out that people have been, in fact, farming for quite a bit longer than that. Nevertheless, in business school parlance, 20 years is one hell of a product development cycle.

It’s worth mentioning that the $500,000 is disbursed over five years, whereas it’s not unusual for seed funding to be wired as a lump sum within 24 hours of getting the good news (and signing the contract). Sure, VC funding certainly arrives with conditions, such as equity and/or board seats for the investing firm(s), etc, but this only serves to deepen the relationship between the allocated capital and its intended outcome – that is, a successful business.

The funny thing about money, you see, is that it creates the opportunity for influence and scale. This is not about getting a pat on the back from a foundation. The problem is that awards like the MacArthur grant simply arrive too late – the opportunity for real impact demands investment, not reward. As such, it has to be paid forward, not back. This is the critical difference between something like the old school foundation model, as exemplified by MacArthur, and the aggressive, agile development model perfected in Silicon Valley that is now being exported to the agricultural community under the rubric of Ag 2.0.

Of course, there is no doubt that the organizations created by people like Rogowski and Allen have been going concerns for a long time, are likely profitable, have provided jobs, etc. But this elides the main question, which is: how do we value something, and when is the most effective point in time at which to value it?

A VC – or any investor for that matter – thinks in terms of return on capital over time, which is itself based on the idea of present value. That is, given a future sum and a fixed interest rate, what is the equivalent sum needed today to match that future sum?

Using Rogowski’s career as an example, let’s assume that it takes 20 years of bootstrapping and hard work to get to the point where a foundation is willing to make such a grant. If I know I’m going to give a $500,000 grant in 20 years, and I assume that the risk-free rate of interest will be 5%, I immediately know that I only need invest $188,444.74 to make good 20 years from now, and I put that capital in my endowment and forget about it (here – try it).

Essentially, the VCs funding Aerofarm are making the same basic calculation, that is, a return based on market rates, but they are paying it forward. In this case, let’s call it the same rate as the above discount rate, or 5%. In 20 years they will have a total of $1.3m, of which $825,000 will be profit. This is simply the minimum return required to justify investing in a project, versus letting it sit in their bank account.

So here is the first big difference: MacArthur at some point said, OK, 20 years from now we are going to kick a half million to some worthy soul (maybe a farmer – or maybe not), so we need to sock away $188,444.74 into our endowment to be ready with it when the time comes. The VCs say, we are willing to bet $500,000 right now in anticipation that someone like Aerofarm is going to provide us with at least the market return, and hopefully much, much more.

The other, bigger difference, is what is happening to the capital in the meantime. In the case of Aerofarm, that money is spent – probably quite quickly – on capital equipment, R&D, new hiring, securing of intellectual property, supply chain and sales development, etc. All of the things that you would need to get a business going and growing. In the case of the foundation model, that money is used to hold long-term Treasury bonds until 20 years of the recipient’s business model has already gone by. That is, if MacArthur wanted to see their money better spent, you could argue that they would be better off paying forward Rogowski with the $188,444.74.

But that would only make sense if they could identify Rogowski as a sure bet. This leads to the third, and most important difference, which is how these perspectives influence funding. Since they are risking their own capital, VCs and other investors fund things they understand. The power of the Aerofarm idea comes from its distilled nature, which goes something like this:

Dear Investor: We can grow food pretty much anywhere. Here is our market size projection, here is our roadmap to commercialization, here are the risks and competition, here is where we break even and become profitable. Here is the projected return on your investment. And here is our bank account and routing info for the wire transfer. Thank you.

If you can’t put a dollar number on soil health, or social justice, or employment opportunities for ex-convicts, then almost any VC will refer you to the pet foundation run by his wife, and politely excuse himself to go find someone who will make him some real money.

Of course, none of this mattered when no one gave a shit about agriculture, and the only people sowing oats were folks like MacArthur. But now that agriculture is coming up big bucks and making global headlines, we are going to see plenty more Aerofarms, which will work over our assumptions about the definition of sustainability in a most uncomfortable way.

Unless the food movement as it is currently constituted can figure out how to create valuation that capital can understand, this avenue of funding will be closed to it, and the the future will continue towards a "tiered" sort of sustainability. This means the wealthier among us can afford, Marie Antoinette-style, to go milking in a “real farmer’s” dairy, while the ever-expanding working poor are fed on food grown in utter isolation from the larger values – physical or social – that constitute the food movement’s halo (and its real value). In fact, this is already happening, as Michael Pollan discovered when he was writing The Omnivore’s Dilemma. What he thought was going to be one section on organic food rapidly turned into two – the “industrial organic” of Horizon as compared to the “real organic” of Polyface Farms. The introduction of agile capital will only exacerbate this divide.

Don’t get me wrong – the debates, such as the importance of organic, matter. And it will always be essential to think about food locally. But, at this moment, what is happening in Brazil matters a whole lot more, and the mechanisms that are funding these trends matter most of all. Ignoring the macro, global scene, in favour of what is local and tangible, forces us into the error of proximity – of literally not seeing the forest for the trees. It is a miscalculation that the current food movement makes at its own peril.

At the event mentioned at the start of this post, a panelist contended that “the food revolution will not be funded by foundations”. I don’t think she anticipated the way in which I agree with her.