Funding in the Food Circle – the Winds of Change

Written by Jo Bennett-Coles

Food. It’s at the heart of all our lives. We love it – we think about it – we plan it – we talk about it.

Never before has there been so much focus on food: where it comes from, how much it costs and how to keep getting it. Just about all of us who have recently bought groceries think: “Wow – that’s a lot more expensive than it was last year.” When I said that recently to a good friend, she responded that this must be due to inflation and Ukraine. I thought: that is too simple an answer.

At the same time, at FGI, we are seeing a marked increase in the number of food and agricultural-related financing opportunities globally. And that’s the thing – it’s global. Not on one continent.

So, what’s the driver? Because, sure as eggs are eggs, it’s not all due to inflation and Ukraine.

To understand what is happening in the world of food and food production, you need to go back in time – well before the war in Ukraine. This goes back years and is best articulated by the EAT-Lancet Commission Report – Healthy Diets from Sustainable Food Systems (“Report”). Whilst this is a rather dry report, the underlying message is critical:

“Without action, the world risks failing to meet the UN Sustainable Development Goals (SDGs) and the Paris Agreement, and today’s children will inherit a planet that has been severely degraded and where much of the population will increasingly suffer from malnutrition and preventable disease.”

The challenge is how to feed a global population with enough good food by 2050 given the world’s limited resources and climate change, also, how to do it sustainably.

As the Report says, “transformation to healthy diets by 2050 will require substantial dietary shifts. Global consumption of fruits, vegetables, nuts and legumes will have to double, and consumption of foods such as red meat and sugar will have to be reduced by more than 50%. A diet rich in plant-based foods and with fewer animal source foods confers both improved health and environmental benefits.”

The calls for climate change have been ringing out – and for a long time. We have natural tools such as Seagrass, which captures carbon up to 35 times faster than tropical rainforests and, even though it only covers 0.2% of the seafloor, it absorbs 10% of the ocean’s carbon each year. This makes Seagrass an incredible warrior in the fight against climate change. However, we have not been kind to our planet in our demand for industrialization and development over many decades. There is growing recognition that chemicals can kill and, only a few weeks ago, came the news that the Dugong, a marine mammal similar to an American manatee and heavily reliant on Seagrass, has disappeared from China’s waters because of pollution.

The world movement to affect change is powerful and the subject of climate change has been at the forefront of many government policies. It is already clear that plant and animal production is being affected. What you have historically grown and where you can grow it is under pressure. The end result will be food migration – farming specific things in different places to cope with climate change. Inevitably, this will also impact where people live.

The food supply chain has also been under a microscope. Another important quote from the Report is this: “The Commission acknowledges that food systems have environmental impacts along the entire supply chain from production to processing and retail, and furthermore reach beyond human and environmental health by also affecting society, culture, economy, and animal health and welfare.” In effect, pull one string and another will give way. But you have to start doing something.

The spending focus and development budgets made available for the food and agricultural industry have been huge.

In August 2022, President Biden signed into law the Inflation Reduction Act, which contains the largest climate investment by the U.S. federal government in history, including over $430 billion to reduce carbon emissions. That is huge and many other countries have been doing likewise. Why? When the timeline is short, you need to throw money at the problem.

What does this mean for businesses operating in the food and agriculture sector? It’s not hard to see that, against this backdrop, there are lots of grants and specialist loans available to improve processes and operate more sustainably and to do it now.

So, prices were already increasing across the board because the days of cheap, unsustainably produced food, are changing.

Then you throw petrol onto the fire. Two major events happened. Firstly, COVID, which stretched the supply chain and heightened concerns about food security. Secondly, the war in Ukraine, which has taken a major global-food production country offline and impacted commodity prices.

What does this mean for food production businesses? Their products are in demand. Original sources of supply cannot or may not be able to meet their needs. Raw material prices have gone up. Sale prices to their customers will have to increase. There is not time nor opportunity to source products that will take a long time to reach their destination.

The working capital cycle for these businesses is changing – and now it is changing really fast. You have to pay more for your raw material. You may need to pay upfront and internationally to buy well or get the quantities you need. All of this before you are paid by your customers. Your customer base may be changing. This is a volatile situation. Time is of the essence.

From the borrower’s perspective, this is a changing landscape. Critical to them is the size and flexibility of their facility. With increased raw material costs come higher levels of collateral. Great news that a borrower wants to grow their facility, but this is an immediate need.

Where a borrower once targeted its business development activity and to which groups of customers and their geographical location – these elements are likely to be changing too. Increasingly, borrowers in this sector are having to pivot to new markets with different sources of supply. Near-shoring and on-shoring dynamics come into play.

Getting an incumbent or new lender comfortable with these changes in the current climate may not be as speedy a process as it was 12 months ago. Borrowers need to plan ahead, and the smart ones are doing just this. Using the services of advisers can help to achieve optimum results in tight timescales. This was important before the volatility in the financial markets. It is critical now.

Other considerations will include PO or trade finance funding, country limits and customer concentration and creditworthiness – all of which need to be built into the structuring conversations.

As a lender, approaching the demands of this sector and structuring such a facility so it is fit for purpose is key. Where the product is located, how it moves and how long it takes to get from A to B are vital questions. Understanding what happens in the food production process and where there may be challenges to the collateral must be carefully analyzed. Funding the inventory will increase the borrowing base, but if the inventory resides in different geographical and international locations, consider what specific reserves might apply, such as Retention of Title. Lenders need to also consider the risk of downturn, and how that might play out for the food producer. For example, is the product considered luxury or seasonal? Will the financial headwinds affect revenue and margins for the food producer, in particular, over the next 12-24 months?

Segueing back to the earlier themes in this article, for many lenders, sustainability considerations are prevalent because of their own policy drivers. Borrowers in this sector are already on that highway and focused on delivering to meet the environmental challenges – they face some tough headwinds. And remember, this is not just the food producers alone. It is the whole of the food chain. That is a long chain with a lot of impact.

It affects us all.