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Hard truths from a decade of investing in regional food systems

We need to change both who we fund and how we fund if we want to create an equitable, thriving future.

Stock art to suggest investments in food systems

The COVID-19 crisis has highlighted the inequities and fragility of our industrialized food system and accelerated the movement to create strong regional food systems that support local growers, provide food security, give communities agency over their food supply and yield environmental benefits.

These systems will remain out of reach, though, unless we address persistent, decades-old structural issues. Price pressures continue to challenge the viability of decentralized food systems and communities of color continue to be underserved — as farmers, food chain workers, supply chain entrepreneurs and consumers. We need to change both who we fund and how we fund if we want to create equitable, thriving regional food systems.

What will it take to achieve such massive shifts? RSF Social Finance has been reflecting on that question as we wind down our Food System Transformation Fund, a pooled loan fund launched in 2010 to help rebuild regional processing, manufacturing and distribution infrastructure that was lost as the food system industrialized. Restoring these supply chain links is essential to creating viable regional food systems, yet community-based infrastructure enterprises have limited access to both startup and growth capital.

The Food System Transformation Fund attempted to address that problem with program-related investments from foundations, on the premise that risk-tolerant debt could enable early-stage businesses to grow and eventually access traditional capital from banks and community development financial institutions. As we wind down the fund and move our food system investments into other RSF portfolios, we’re sharing what we’ve learned in hopes of advancing efforts to build a regenerative food system.

Investors seeking a better food system need to take the time to understand a company’s impact and its beneficiaries, toss out traditional assumptions about market rate returns and ensure that terms benefit communities.

Over the past decade, the fund provided $6.5 million in debt to 27 organizations across 14 states. More than 25 percent of borrowers grew into our senior secured loan portfolio or accessed traditional debt, while nearly 20 percent had to cease operations or substantially change ownership.

The enterprises between those two poles continue to need patient, flexible and diverse capital structures. That’s not because they’re failing, but because the finance ecosystem has failed to develop tools fitted to the needs of food system enterprises. This truth informs three fundamental insights from our work in the field of food system transformation.

1. In food systems, high impact and high returns don’t mesh

Investing in food systems is very different from investing in a trendy plant-based–meat startup or a consumer packaged goods company that can outsource manufacturing and build a brand for sale to a conglomerate. Food system businesses are capital-intensive — they require substantial investment in processing equipment, trucks and warehouses — and they operate in a highly competitive, low-margin sector.

Immense price pressure in the U.S. food system compresses gross margins and makes it challenging for food infrastructure businesses to achieve profitability. Our spending on food doesn’t reflect the true cost of production: Americans spend only 9.5 percent of their income on food, compared with 15 percent in Canada, 13 percent in France and 23 percent in Mexico. Most small farms in the U.S. aren’t profitable; on average they earn only 17.4 percent of every dollar spent by consumers at stores. Workers throughout the industrialized food system face poor working conditions and low wages.

Many food system infrastructure businesses are trying to fix these inequities, and it’s imperative for investors to understand the tradeoffs between returning capital to investors and reinvesting that capital into the business and the community.

This issue is most glaring with the venture capital model. When venture-backed companies disrupt local food systems and don’t have the longevity or the relationships to create long-term impact, they actually can harm communities. In the worst-case scenario, these companies launch, rapidly scale, seize market share from existing community-based businesses and then run out of cash, leaving the community with less than it had beforehand.

Similarly, pulling out high financial returns for investors undermines the positive changes these companies can achieve and puts more pressure on a strained, inequitable system. Investors seeking a better food system need to take the time to understand a company’s impact and its beneficiaries, toss out traditional assumptions about market rate returns and ensure that terms benefit communities.

2. Farmers and communities can’t bear the risk

Traditional financing tools are seldom structured in a way that shares risk across the system. When times get tough, capital partners must navigate the delicate balance of principal return to investors versus making farmers and local food systems whole. Traditional collateralized loans place the burden on those least able to bear risk — the community-based enterprise and its stakeholders.

The Food System Transformation Fund primarily issued debt backed by collateral — equipment, vehicles and accounts receivable. When portfolio companies had to cease operations, we had to choose between returning capital to investors or letting the company repay farmers and other community partners. Our investors prioritized community well-being, and we were able to forgive debt in these cases, but this is a structural problem that shouldn’t require an 11th-hour solution based on investors’ goodwill.

When venture-backed companies disrupt local food systems and don’t have the longevity or the relationships to create long-term impact, they actually can harm communities.

One way to distribute risk more equitably is to integrate various forms of capital — financial, social and technical — within the same transaction to support an enterprise.

This may mean some combination of unrestricted grants, debt, equity, loan guarantees and forgivable loans. Guarantees can unlock capital that otherwise wouldn’t fund the space and forgivable loans can help businesses prioritize impact, which often takes a back seat to financial return.

For example, if the enterprise is meeting its impact objectives but experiencing financial or operational challenges outside its control, the loan can turn into a grant. Funders need to be creative and partner with food system enterprises to find the optimal mix of tools to support the business and its stakeholders.

3. Transforming the system will require philanthropic, public and private capital

While there is a lot of interest in food system enterprises, the current funding ecosystem is weak. The capital needed to build these businesses is hard to come by and even harder to sustain over the long term. The funding is not readily available in many regions where the work is happening, and it is not equitably distributed. As in many sectors, entrepreneurs of color are woefully underfunded.

Philanthropic capital, with its flexibility and public benefit purpose, is well-positioned to seed the space and attract other funders. Foundations and donor-advised funds can support this work not only through grant-making but also through investments and leveraging their assets to unlock capital from more-traditional lenders or community development financial institutions (CDFIs). These types of organizations steward deep relationships within their communities and are well-positioned to fund food system enterprises.

Federal programs provide critical resources to local food organizations and small farmers, but support for sustainable food systems makes up only a fraction of the public funding allocated for agriculture. Increasing this share would have a multiplier effect. As more philanthropic and government funding flows into the food systems space, more private capital will find its footing there. Many enterprises in our portfolio accessed USDA grants to support early-stage programs and center equity in their work.

The field needs all sources of nonextractive capital, which ranks community benefits above investor returns. But we have found that food system enterprises are best served when community-based funders lead. Food systems vary widely across rural, urban and geographic divides. Funders that hold direct relationships with food system entrepreneurs and ecosystem partners more clearly understand the regional food supply chain and are able to make more informed and effective funding decisions.

The way forward

Over the past decade, much has changed across food and finance systems. Consumers increasingly value sustainable and local production methods, and more funders are entering the space, especially with sustainable food production emerging as one solution to our climate crisis.

With COVID-19 thrusting the inequities of our food system into the forefront of the national conversation, we must use this moment to catalyze investment into food systems that care for farmers, food chain workers, eaters and the environment.

If we want to decommodify our food system, we must decommodify our food financing system. We need tools with impact-adjusted return expectations; we need investors and donors willing to redistribute risk; and we need local, integrated capital solutions. With those assets in hand, we can realize the vision of a regenerative food system that serves everyone.

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