Regen Roadblock: Why Capital's Not Flowing to Regenerative Agriculture

Current sources of capital aren't funding the transition to regenerative agriculture.

In a prior article, I shared three observations:

1. There’s real interest throughout the ag value chain to transition to regenerative agriculture. This includes growers, processors, aggregators, ingredient companies, brands and farmland investors.

2. Each of these parties needs capital to transition.

3. The capital’s not showing up.

Why is that? Here we’ll look at the major constraints on getting capital deployed to regen.

Some quick context to start. Broadly, there are three headwaters of capital that flow to farms and farmland stewards:

1. Consumers: payments for products to retailers and then upstream to distributors, brands, manufacturers, ingredient companies, processors & elevators and finally to farmers and ranchers

2. Investors: large institutional investors (e.g. pension funds) in farmland funds on one end and public market investors on the other

3. Lenders: financial institutions and alternative lenders that underwrite farm mortgages, operating loans and equipment loans

Regen faces barriers on all three fronts.

First, let’s look at the biggest market force, consumers.

In prior market shifts in ag -- organic in particular -- consumers paid a premium (and still do!). These premiums make their way through the value chain to shift behavior and compensate manufacturers and producers for value-added attributes.

However, consumers have demonstrated very little willingness to pay a premium for regenerative products.

This is understandable -- regen is esoteric and nuanced, and it's very hard to understand without an awareness of food & fiber supply chains. Not to mention that there's no agreement on "regenerative" standards across brands or certification efforts.

Premiums may emerge over time. I hope they do. There are nascent pockets budding, and there are early reports of certifications getting agreement from brands to pay premiums.

On the other hand, it’s just as likely that they won’t become common. There’s speculation among knowledgeable supply chain experts that wholesale buyers will try to make regen practices a standard part of procurement requirements across commodities over the long-term.

In short, there’s no premium now, and there’s no strong signal of a durable one emerging.

As a result, food and fashion brands are stuck, even if they want to reengineer their supply chains:

• Absent premiums, there's very little margin in their current economics to incentivize upstream producers and manufacturers. Basis points of margin matter in these large companies, and it’s difficult to reduce margin without getting punished by the market. (Case in point: the former CEO of Danone who was removed by activist investors for his commitment to climate-positive initiatives.)

• This constrains investment in supply chain reengineering. Commodity supply chains are, by design, both opaque and dynamic. This fungibility of producers creates the virtues needed by industrial production: durability of supply, consistent quality, and safety – but creates extremely complex & multivariate barriers to re-engineering at scale. When there’s no premium, there's rarely budget in procurement for scaled implementation that both expands procurement requirements and adds cost. Bespoke regen pilot programs in brands are becoming common – many brands are trying to figure this out. But taking it to the next step of scaled implementation is very, very rare because regen doesn’t fit the common business case of the last major transition.

So: no consumer premiums means little investment from brands and wholesale buyers.

The second headwater of capital is investors, primarily farmland investors and public market investors in food and fashion brands.

• Farmland investors are also inhibited by the lack of a consumer premium. Large institutional buyers of farmland have the capacity to buy and convert farmland to regenerative ag, but the business case has yet to be developed. In the past, the organic premium allowed these investors and other farmland owners (e.g. growers) to underwrite transitioning acreage to organic production practices. However, because there isn’t a  premium in regen, the models that underpin organic farmland transition don't apply to regenerative transition.

• How about public market investors? One particular public market vehicle, green bonds, appears promising. Green bonds enable large public companies to issue debt to fund sustainability initiatives. Some of the largest, most forward-thinking brands are issuing green bonds to partially fund supply chain transition, led by Pepsi, Walmart and VF (the parent company of The North Face, Timberland and other brands). However, they only provide a portion of what's needed. For example, Pepsi is using the proceeds of green bonds to invest $216M across 3M acres. That's impressive and important. And it equates to just $70/acre over the next 7 years, or less than 50% of the total cost to transition (a minimum $150/acre in the U.S.). In no way do I want to disparage these efforts. They’re a critical part of the transition finance stack. However, adoption is very, very early and in the cases where it’s being implemented, it doesn’t appear to be sufficient for complete acreage transition.

So: there's no repeatable or scalable model yet for either farmland or public market investors to deploy capital to regen.

That brings us to the third source of capital: financial institutions.

Welp, ag finance is rooted in conventional ag practices.

In the U.S., farm operating loans, mortgages, crop insurance and federal loan guarantees are tied to "best agricultural practices" which are defined in the context of chemically-intensive monocropping or commodity livestock breeding and production. Their underwriting and risk models are based on these industrial management practices, and they're either unfriendly to non-standard regenerative management practices or actively view them as a risk.

These financial structures are meant to support farmers, protect lenders and ensure our nation's food security. The unintended consequence, however, is to lock growers into specific management practices, even when a better way emerges.

In contrast, there are some remarkable early efforts underwriting regen transition loans to growers.

The inevitable caveat: they’re offered by small lenders, unregulated by the USDA Farm Service Agency. This means a) they're not covered by federal loan guarantees and b) more challenging, they’re competing directly with lenders who do offer federally-guaranteed loans.

Thus, to charge a competitive market rate to growers, small regen lenders need a lower cost of capital than their guaranteed competitors. It follows then that they can't pay market rate returns to their investors.

As a result, emerging regen transition loan products are primarily funded by concessionary capital, which is very difficult to scale.

This is why less than $100M/yr is currently available in regen transition loans. That's a tiny drop in the ocean of farm debt -- only 0.06% of the $159B annual non-real estate farm debt (USDA ERS 2023).

So, the overall takeaway: capital's not coming from either the retail or capital markets. It's not coming from consumers or brands, it's not coming from farmland investors, it’s not coming from public market investors, and it's not coming from mainstream ag lenders.

There is, however, one place where the economics of regen are blindingly obvious: on-farm.

I'll cover that in a follow-up post.