Sustainable Food and Ag Investments

Last week I spoke at the 2012 AgReturns conference in San Francisco. This was the latest installment in the conference series that used to be titled Ag 2.0. I guess the organizers changed the title to inspire attendees to drive for exits and financial returns in this nascent sector for venture investment!

The conference featured presentations from entrepreneurs and investors from the food and Ag sectors. Topics included precision agriculture, sustainable Ag inputs, Ag-biotech, and food and Ag consumer products and services.

My talk was on the correlations between venture investing in Cleantech and AgTech. A couple of years ago I used to sit on panels with titles such as “Is AgTech the new Cleantech?” Given the sparsity of positive investment returns to date in the Cleantech sector, I’m not sure that being the “next Cleantech” is necessarily the right direction for AgTech. An alternative question might be, “Is Food/Ag the next exciting vertical for Tech?“. However, there are definitely some valuable lessons to be learned from the last 5 years of Cleantech investment which can be applied to the more nascent AgTech sector.

Look for scalable, capital efficient investment opportunities

If the industry can extract one key lesson from the last 5 years of Cleantech investing, it’s that the best opportunity to produce venture-level returns comes from companies with scalable, capital efficient business models. Just as Cleantech has its multi-$100MM solar manufacturing, wind and biofuels sectors, there are plenty of opportunities to sink 9 figures into investments in the AgTech sector. Since speaking at the AgReturns conference I’ve received business plans ranging from multi-$100MM fertilizer production plants to designs for new combine harvesters. There are, however, a number of emerging AgTech businesses that leverage low cost sensors, ubiquitous cloud-based data, and supply chain logistics to produce scalable businesses that look a lot like the promising resource efficiency and demand reduction companies emerging in the Cleantech sector.

Look for focused go to market strategies

One of the challenges with bringing new solutions to market in the Ag sector is a fragmented customer base that is extremely conservative towards adopting new technology. Selling new irrigation/fertigation or SaaS software solutions directly to farmers is slow, inefficient and not cost effective. Several speakers at the Ag Returns conference gave examples of how they’ve succeeded in using co-ops, contract grower groups, and established channel partners to solve this challenge.

It’s all about the team

I’ve always been a “back an A Team with a B product, rather than a B team with an A product” investor. One of the challenges for the AgTech sector has been a lack of experienced entrepreneurs. This is beginning to change as entrepreneurs from the Cleantech, Biotech and IT sectors identify opportunities in some of the leading AgTech startups. This is a positive development for the sector, which should accelerate the growth of category creating companies.

We need some exits to validate the sector

The Cleantech sector languished for several years until some of its marquee names (Tesla, Solazyme, First Solar) demonstrated the returns that could be achieved. At the AgReturns conference, John Ryals from Metabolon presented an excellent summary of the returns in the AgTech sector to date. Unfortunately, the list of exciting exits is still relatively short. Everyone talks about the 13X return from Athenix and then struggles for a second example. As I’ve discussed in a previous posting, one promising opportunity for value creation is likely to be where the Cleantech and AgTech sectors converge in the production of biomass feedstocks for bio-conversion to fuels, chemicals and materials. Just before the AgReturns conference, Ceres had a public offering of $65MM at a market cap of $350MM. The other leading biomass seed and production companies, Chromatin (a Physic Ventures portfolio company) and Mendel, are also showing great progress.

Areas to watch

At Physic Ventures, we believe there are a number of attractive investment sectors emerging in AgTech and FoodTech. In the AgTech world, we believe that consumer demand for safety and transparency, coupled with increasing regulatory pressure creates an attractive opportunity. There will be large markets for companies developing solutions that make the food supply chain safer, reduce wastage and provide transparency to consumers.

In the FoodTech sector, Physic Ventures recently led the Series B financing of Yummly, a leading website providing information on how to select, procure, and prepare healthy, nutritious and delicious food at home. I will cover the context for this investment and the range of new opportunities it highlights in a future posting. Needless to say, this is a great example of how Food and Ag are emerging as a promising vertical for applying the modern toolkit of consumer facing tech solutions.

The proliferation of collaboration

Regular readers of this blog know that collaborative consumption and the share economy are investment sectors our venture fund, Physic Ventures, is particularly bullish on.  These sectors sit at the intersection of resource efficiency and the enabling technologies of social graphs, cloud data storage, and mobile computing.  Collaborative consumption startups are disrupting numerous industries, such as transportation, housing, and entertainment.

In the last year, we’ve seen an explosion of entrepreneurial and investment interest in these sectors.  Two excellent books written by Lisa Gansky and Rachel Botsman and Roo Rogers have catapulted Collaborative Consumption and the Share Economy from novel concepts to everyday buzz words.  Lisa’s book and accompanying website have cataloged over 5000 startups in the Mesh ecosystem. Last week also marked the one year anniversary of the Collaborative Fund, setup by Craig Shapiro specifically to invest in this sector – Happy Birthday guys!

While I’m delighted to see collaborative consumption receiving the increased attention that it deserves, I’m increasingly concerned by the saturation of some collaborative consumption sectors with me-too startups that have no differentiation, no barriers to entry, and in many cases no viable business model.

Consider one industry where collaborative consumption got started early – transportation.  This sector got off to a healthy start.  There were two early, for-profit entrants in the B2C car sharing sector; Zipcar and Flexcar.  In 2007 they merged creating one company that went on to build sufficient scale for a successful IPO in 2011.  Then the P2P car sharing model began to receive attention and in the space of two years we’ve seen the launch of Relay Rides, Getaround, Spride, Wheelz, Whipcar and numerous others being cooked up in incubators around the world.  All of these P2P car sharing companies have essentially the same business model, minimal IP, and they’re competing for the same customers in the same geographies.

In addition to car sharing, there’s also a promising market for ride sharing.  Physic is a fan and user of Zimride, which has been steadily growing in this sector since 2008.  Last week, a recent graduate from Y-Combinator, RideJoy, was funded to compete for exactly the same market as Zimride.  When asked in TechCrunch how RideJoy is differentiated from ZimRide, RideJoy said “Our focus is really on crafting a great user experience, fostering a warm community and delivering amazing support.”  The last time I checked, Zimride had a pretty great user experience, community and customer support, so it remains to be seen how RideJoy is planning to differentiating itself.

We’ve seen this story play out before in many other consumer internet sectors.  Before E-Bay emerged as the leading online auction company, there were numerous startups offering the same online auction service, with limited switching costs, and no established brand loyalty.  Eventually network effects kicked in and everyone wanted to list on the site where all the customers were.

Here’s a prediction:  As more P2P car sharing and ride sharing companies compete for the same customer, there will first be downward pressure on margins as new entrants try to compete on price.  This will drive the less well funded companies out of business.  Then someone will create the “Kayak of ride sharing”, which will put additional downward pressure on margins by forcing competitors to explicitly compete on price, perhaps to the detriment of quality.  This will drive consolidation in the marketplace and eventually one or two leading companies will emerge.  This rapid process of creative destruction can be healthy for the eventual winners and may lead to better services for consumers through increased competition.  However, it makes it extremely hard for institutional investors to identify potential winners and commit the level of investment required to create a truly great company.

I encourage entrepreneurs interested in the potential of collaborative consumption to think about how to build a business with a differentiated model and barriers to entry.  This doesn’t have to be IP.  It could be exclusive partnerships in the ecosystem, a trusted consumer brand with long term loyalty benefits, a business model with inherent network effects from increased scale, or a sticky component to the product offering.  Within the Physic Ventures portfolio we have several examples of how to achieve this.  Recyclebank established itself as the leading recycling rewards company by signing long term, defensible partnerships with municipalities.  Gazelle became the leading reCommerce company by offering “crazy-awesome” customer experience that built long term loyalty, along with long term partnerships with retailers.  EnergyHub is democratizing residential energy efficiency through cloud based services that run on its proprietary hardware.

Finally, entrepreneurs could also think about building a collaborative consumption business in sector that is less crowded than transportation, accommodation, or travel experiences.  For example, the founders of Cloo are unlikely to see any competition in their sector any time soon!

2012 Sustainable Living Thesis

Physic Ventures follows a thesis driven investment practice.  At the beginning of each year we review the recent science and technology developments, markets trends, and regulatory drivers that influence our investment practice. We use these to develop a thesis for which sectors and business models we expect to provide attractive investment opportunities.

Throughout the year we select some of these sectors to perform a deep-dive landscape analysis.  We talk with numerous companies in the sector, their customers, their suppliers, and their competitors.  We develop a position on what we think the leading company in a given sector should look like.  If there’s already a company that fits our model, then we’ll explore whether we can invest in that company.  If such a company doesn’t exist and we think the opportunity is large enough, then we recruit the entrepreneurs, acquire the technology and identifying the partners to create a category leading company.

Here is the first draft of our 2012 Sustainable Living investment thesis.  For regular readers of this blog, you won’t be surprised to see an emphasis on investments in resource efficiency.  We continue to look for opportunities to increase adoption of the traditional 3Rs: Reduce, ReUse and ReCycle, as well as focusing on the collective behaviors of Collaborative Consumption and the Share Economy.

One area that we’re paying increased attention to 2012 are opportunities at the intersection of Big Data and Sustainability.  This trend is driven by the growth in ubiquitous connectivity, low cost cloud-based storage and computation, and an industry recognition that businesses providing data-enabled resource efficiency are both capital efficient and rapidly scalable.  This sector is often referred to as Green IT.  I prefer the description of Spring Ventures founder, Sunil Paul, who calls this sector the CleanWeb: “a category of clean technology that leverages the capability of the Internet, social media and mobile technologies to address resource constraints.”  Irrespective of it’s name, in 2012 we expect to see businesses harnessing the power of cloud storage and computation to address resource constraints in sectors as diverse as energy, materials, food, water, and transportation – just to name a few.

We’ve already made a great start to building a portfolio in this sector with companies like EnergyHub, Gazelle, GoodGuide, Recyclebank and WaterSmart.  We look forward to adding several more in 2012.  It’s going to be a busy year!

If you think we’ve missed an exciting sector or business model within sustainability, let us know where you think are the opportunities for highest impact.

Inspiring Sustainable Living

Unilever is a strategic Limited Partner in the current Physic Ventures fund.  We invest capital on behalf of our strategic partners and work with them to add growth resources to our portfolio companies.  Unilever is a global consumer products company with over $60 billion in annual revenues from food, beverage, home and personal care brands that are used by more than 2 billion consumers every day in over 180 countries.  Unilever is also a global leader in sustainability.  Last year Unilever published its ambitious Sustainable Living Plan which aims to double Unilever’s revenues by 2020 while simultaneously halving its environmental impact.

This Sustainable Living Plan has two components.  The first is to make each product more sustainable by greening supply chains, manufacturing processes and distribution networks.  The second goal is to reduce the environmental impact of consumers using Unilever’s products.  For a consumer goods company, it is this consumer usage which has the greatest environmental impact.  For example, the carbon emissions and water usage from taking a shower with Dove shampoo or doing laundry with Persil detergent are far greater than the environmental impact of manufacturing those products.

Changing the way consumers select and use products turns out to be more challenging than greening the production of those products, so Unilever has been doing a lot of research into this consumer behavior.  This week Unilever released a new report on how Unilever plans to inspire its consumers to adopt more sustainable practices while using its products. They have identified 5 keys to inspiring sustainability: make sustainability habitual, provide consumers with sustainability information, make sustainability rewarding, make it desirable, and make it easy.  Here’s a short video summarizing Unilever’s approach:

At Physic Ventures, we have developed a Network Innovation model that uses the insights developed by our strategic partners to inform our investment practice.  We provide reciprocal insights to our strategic partners by sharing the technologies, services, and business models in which we are evaluating an investment.  Once Physic has invested in a company, we work to facilitate partnerships with our strategic partners, like Unilever, to accelerate the growth of that portfolio company and help our strategic partners achieve their growth and sustainability goals.  Unilever’s recent report on how to Inspire Sustainable Living provides two great examples of how this Network Innovation Model works.

In 2009, Physic invested in GoodGuide, the leading source of information on how the health, environmental and social performance of products aligns with consumers’ preferences and values.  GoodGuide is delivering on Unilever’s finding that consumers make more sustainable choices when they understand the sustainability benefits of the products they are choosing.  GoodGuide is also helping CPG companies understand which sustainability values are the most important to consumers.

Another Physic investment that was influenced by our discussions with Unilever’s sustainability team was our investment in Recyclebank.  Earlier this year, we identified Recyclebank as the leading company providing consumer rewards for taking a broad range of every day green actions. This approach perfectly aligns with Unilever’s finding that rewarding sustainable choices helps reinforce those behaviors.  Since completing our investment in Recyclebank, Physic was delighted to help facilitate a partnership between Recyclebank and Unilever based on Recyclebank’s rewards service.

In addition to these two examples of Physic portfolio companies that are now working with Unilever, Physic has recently made a number of other sustainability investments where our investment thesis was based on similar themes to Unilever’s plan to Inspire Sustainable Living.  For example, our investments in companies such as EnergyHubGazelle, and WaterSmart all align with the themes of making sustainability habitual, desirable, easy, and rewarding.  As I have discussed in previous posts, we believe these are enduring themes that can harness the technology of social connectivity, mobile access to information and collaborative consumption to help us all adopt more sustainable lifestyles.

Troll Trouble

It has been an interesting week in the usually sleepy world of patents. Google’s $12.5B acquisition of Motorola Mobility and Apple/Microsoft’s $4.5B acquisition of 6000 Nortel patents highlight just how high the stakes have risen in the smartphone patent battle.

While all the media attention is focused on these sensational, multi-billion dollar patent battles between industry titans, little attention has been paid to how the dysfunctional US patent system is affecting early stage innovation and entrepreneurship. Eric Schonfeld’s recent TechCruch posting references a PWC study which describes how successful so called “non-practicing entities” have become in filing patent law suits. Ten years ago, the majority of patent settlements were paid to “practicing entities”, i.e. operating companies whose IP was judged to have been infringed by a competitor. In recent years, “non-practicing entities”, commonly referred to as trolls, have refined their strategies and identified friendly Texas jurisdictions which provide them with larger and larger payouts. This has encouraged yet more trolls to get into the game of acquiring patent portfolios and the whole situation risks spiraling out of control.

Within our portfolio of tech startups at Physic Ventures, this rise of the trolls is having two serious negative consequences:

Trolls are imposing an “Innovation Tax” on startups
Several of our portfolio companies have been hit by frivolous patent infringement accusations by trolls. Typically, the troll will write to a startup and accuse them of infringing an extremely broad patent related to widely used technology, such as Wi-Fi. The trolls have done their research and figured out the maximum that a startup could afford to pay for a license and they offer the startup the chance to take a license on those terms. The startup is faced with the unpleasant choice of succumbing to this shake down and paying the “license fee” or risking far higher expenses by defending themselves in a potential suit. These license fees consume extremely scarce cash resources, typically at a time when a startup is just launching its first product and needs to preserve every last dollar for product development, marketing and BD.

Business partners are practicing “Defensive Partnering”
Trolls get really excited by the opportunity to shake down a large corporation who can afford much higher license fees than a startup. As a result of increased Troll activity, we’ve observed several examples of potential partners that are reluctant to work with a startup unless that startup indemnifies the larger partner from any patent infringement costs associated with the startups product. Startups simply can’t afford to do this and so mutually valuable partnerships end up not getting signed because of a potential patent trolling.

It is important to point out that these unhealthy dynamics are almost exclusively related to the IT industry and software, in particular. Our investments in materials science and life science continue to focus on developing IP that will be valuable to potential partners and acquirers. While the glacial pace of the USPTO is a frustration to these companies, their business model still functions well.

Perhaps it is time to rethink how IP in software and tech is protected.  We should be able to continue supporting and rewarding tech innovation, without stifling it with frivolous and opportunistic exploitation of the current patent system.

The Future of Venture Capital

This week I graduated from the Kauffman Venture Fellows program.  It was a proud day for me and my mentor in the program, Will Rosenzweig.  The Kauffman Fellows program is designed to develop future leaders of the venture capital industry and share best practices in entrepreneurship and innovation. Since its creation 14 years ago, graduates from the Kauffman program have collectively made $6 billion in venture capital investments, creating hundreds of new companies, which generate $15 billion in annual revenues, and have generated 50,000 jobs.

The subject of this posting is the makeup of my Kauffman class, the topics we discussed at yesterday’s Affinity Graduation Day and how these portend to the future of the Venture Capital industry.  With 29 Fellows, my graduating class is the largest and most diverse class of Fellows in the history of the Kauffman program.  The fellows represented venture capital firms from 10 different countries and 8 different US states.  These included the traditional innovation regions of San Francisco, Boston and New York, high growth, emerging economies like China, India, and Brazil, and countries with nascent venture capital industries, such as Mexico, Italy, and the Palestinian Territories.  The fellows also represented a broad range of venture capital investment models from Incubation to early stage Angel and Micro VC, to traditional VC, to Secondary Investors and Venture Philanthropy.

This amount of geographic and investment model diversity is relatively new for the Kauffman Program.  As the chart below shows, for the first 8 years of the program all the Kauffman Fellows were based in the US, and 80% worked in San Francisco and Boston.  In the last few years, only 60% of the fellows were US based and only 40% worked in San Francisco and Boston.  It was announced this week that the 2011 incoming class of Kauffman fellows will continue this trend and be the first class with less than 50% of the fellows working in US based firms.

This growing diversity reflects the fact that venture capital and entrepreneurship is now intrinsically a global business. For example, even though my firm, Physic Ventures, invests exclusively in US based companies, nearly half our portfolio has business activities in Europe or Asia.  These include manufacturing products in China, performing R&D in India, and outsourcing software development to Eastern Europe. This is a profound change for the Venture Capital industry.  When the Kauffman program began in 1996, most VCs only invested in companies within an hour’s drive from their office.  Entrepreneurs and service providers were clustered close by and beta customers were also local.  These days, the global reach of the internet, the low costs of outsourced R&D and manufacturing, and the emergence of entrepreneurial talent around the world means that, while venture investing remains mostly a local activity, every startup needs to have a global perspective from day one.

In additional to geographic diversity, the other key topic of yesterday’s graduation day was the growing diversity in how companies are financed at inception and new ways for VCs to exit investment positions to return capital to their LPs.  I moderated a panel where Blair Garrou described the successful Micro VC model that his firm, DFJ Mercury, has developed for investing in capital efficient, early stage IT and science companies.

On the same panel, Eugene Song from W Capital described the rapid growth of secondary funds who purchase both individual investments and subsets of portfolios of direct investments.  In the last few years, this secondary asset class has grown from a niche asset class to deploying over $10B in 2010.  This growth in secondary transactions is driven by the need for alternative ways to monetize investments in an era when it is taking more time for US ventured-backed companies to reach an exit.  In 2010 the median time from first investment to IPO reached 9.4 years, the longest on record.  When compared with an equivalent time to exit of only 2.6 years in China, it is easy to understand the current enthusiasm to invest in Chinese funds.

Saed Nashef

Finally, I want to take a moment acknowledge one of the many exceptional people in my Kauffman class.  Saed Nashef joined the Kauffman program two years ago with the goal of starting a new venture capital firm in the Palestinian Territories.  Like many of my classmates I thought this was an admirable goal, but in the dark days of 2009 when half the venture firms in silicon valley couldn’t raise capital, I doubted many LPs would be willing to take the risk of investing in a first time fund, located in the West Bank.  Well, Saed proved us all wrong and earlier this year, Sadara Ventures announced it had raised $29MM and is open for business, making its first investments in West Bank based IT firms.  Saed was selected for the 2011 Jiff Timmons award for Entrepreneurial Leadership by his classmates – a most fitting and deserved award for someone who embodies the very best of the Kauffman program and is an inspiration to us all.