This article is Part A of the fifth alert in our series of alerts focused on the alternative protein industry. It provides an overview of financing options for players in the industry and specifically discusses information relevant to early-stage companies.
Newcomers may wish to read our previous articles, which include an introduction to this series, a comparison of the regulation of insect protein as food and feed, a quick guide to JVs in the alternative protein industry and key considerations for early-stage companies in the Alternative protein industry.
1. Market Outlook
Having a clear picture of financing options is key for early-stage companies and will be relevant to players in the alternative protein industry generally, given the significant amounts of investment that the industry has seen in recent years (a record US $5bn was invested in 2021) and the rapid growth we are seeing in companies in this sector.1
For context, the industry predominantly consists of small and/or Nascent businesses, with larger organizations often seeking to invest or purchase these businesses for their technical know-how, intellectual property (“IP”) or growing brands. Injections of capital by larger organizations have mostly gone to companies focusing on plant-based products. However, in the past five years, investors have also notably been diversifying into the fermentation and cultivated meat sectors.2 As a new relatively and developing market (particularly picking up in the United States, Singapore and Israel), investment in the industry has mostly been by way of equity rather than debt. Some key examples include: 3
- Israel-based Brevel (which creates microalgae-based alternative proteins) raised $8.4mn in their seed round (2022);
- French InnovaFeed, a vertical insect farm operator focused on insect proteins, raised $250mn in their Series D round (2022); and
- Singapore-based Next Gen Foods (which produces plant-based meat products) raised $30mn in their seed round (2021) and $100mn in a Series A round (2022) (reportedly the largest ever Series A by a plant-based meat company ).
2. The difference between Debt and Equity
Understanding the difference between debt and equity capital is key for early-stage companies and will help frame the financing options which will be set out in the upcoming Part B of this alert.
Equity investments into early-stage companies, even those experiencing high growth, are inherently riskier (for an investor) than debt investments into the same companies. Although companies in the alternative protein space may own, or otherwise benefit from, certain IP, most will not be particularly “asset rich” in the way a real estate company might be. An investor’s money is tied to the success of the company, and if the company is ever wound up, they (as shareholders) will be the last to be paid back. Further, if the business is sold for less than the total amount that has been invested in it, or, in the worst case, if it is wound up, depending on the rights attaching to the shares received, an investor may not receive all of their money back. This is particularly the case where the company holds few tangible assets.
- Equity does, however, provide investors with a potentially unlimited upside: if a company’s valuation rises, an investor’s shares will also increase in value. Investors with equity in a business will therefore be keen to see a company succeed, which is why they will usually want to be involved in key business decisions, sometimes taking a seat on the board, or appointing an observer to the board. The best investors will actively advocate on behalf of their investee companies, introduce them to business partners, and counsel their founders – through good and bad.
- Equity might seem like an attractive option when a company is growing and its prospects are bright, but founders are usually keen to minimise any dilution of their shares as much as possible. The advantage of operating in a growing market and where a company’s valuation is increasing is that while giving away equity in exchange for investment may dilute the existing shareholders in terms of fractional ownership, overall growth and increased valuations may protect the stakes held by existing investors from being diluted in terms of value.
The quest to modernise the food system and make it more sustainable is only just building steam. The market is growing quickly (although the exact trajectory of growth has yet to be determined) and most sources continue to say that there is real demand for alternative proteins. Holding equity in a company in this sort of market is a great opportunity – but it is clearly not without its risks.
Debt investments have their own risks. While the risk of total loss might be remote, risks still exist upon the ability of a company to repay the principal amount of its its debt, the collateral available to secure any loan and, moreover, the ability of the company to service its debt in a higher interest rate environment.
An early-stage company may find it easier to raise debt if it has real assets, including material IP, receivables (ie, long term supply agreements which would provide future income), or a relatively secure income profile. This is because the company will normally be able to grant security over its assets in exchange for a loan. If the company has no security to grant, the debt will likely be more expensive.
- An investor’s focus when providing debt (whether a bank, direct lender, sponsor, corporate, angel or otherwise) is to ensure that they can get their money back (plus interest). They will therefore be focused on sufficient due diligence to make sure that the debtor can service the debt and on carefully negotiating the loan instrument, to ensure that they mitigate the risk of the investment as much as possible.
- Founders and early-stage investors may be keen to seek debt investment if they feel that they will comfortably be able to service the debt, particularly when offers from those willing to invest equity do not value a company as highly as its management may have anticipated or where founders and management want to minimise the dilution of their shares in the company. That being said, in a higher interest rate environment, debt service may prove much more costly than originally planned.
Companies that are not yet or are only just generating positive EBITDA may wish to consider debt financings that cater to this dynamic, including recurring revenue loans and accounts receivable financings. Recurring revenue loans provide periodic borrowed amounts to help a company to continue operating while waiting for the future, expected (ie, “sticky”) revenues arising from customer contracts. The availability and size of such loans depends on a company’s revenue stream and the recurring nature of it (from the customers of the business) (see our previous alert on recurring revenue loans). Another debt financing option that may be considered is accounts receivable financing, where an early-stage company borrows against its outstanding customer invoices. A careful analysis would be needed to determine the availability of these types of lending.
The table below provides a helpful comparison of equity vs debt capital.
Equity is injected into a company through (i) the issuance of shares, or (ii) convertible loan notes (these are loan instruments which convert into shares at a particular point in time – we will consider these in Part B of this alert).
Advantages of share lending:
Share financing considerations:
Advantages of Debt:
Alternative protein companies benefit from equity and debt funding options. Deciding on the best option requires careful consideration of the points outlined above and will be influenced by a number of factors, including a company’s growth profile, asset base and profitability. Early-stage alternative protein businesses frequently involve new technology and products, which require thorough R&D before becoming market-ready and profitable. Therefore, such companies may find equity funding the optimal route. Mid or late-stage alternative protein companies may determine that debt financing offers the flexibility required to support continued growth, particularly on a non-equity dilutive basis.
Julia Kotamäki and Michelle Luo, London trainee solicitors, contributed to the drafting of this alert.
1 Good Food Institute: Record $5 billion invested in alt proteins in 2021, surging 60 percent since 2020 (Record $5 billion invested in alt proteins in 2021 (gfi.org))
2 Good Food Institute analysis of PitchBook Data, Inc. (Record $5 billion invested in alt proteins in 2021 (gfi.org))
3 Good Food Institute: 2021 State of the Industry Report – Plant-based meat, seafood, eggs and dairy (https://gfi.org/wp-content/uploads/2022/04/2021-Plant-Based-State-of -the-Industry-Report-1.pdf)
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal based on particular situations.
© Morrison & Foerster LLP. All rights reserved