The Six Risks of Alternative Protein Companies
“Only those who will risk going too far can possibly find out how far one can go.”
– T. S. Eliot
Change isn’t easy. Alternative protein companies, at least in their current manifestation, emerged on the scene nearly 15 years ago with a bold and compelling mission to provide products that taste just as good, cost the same or less, yet are better for humans, animals and the planet. While it remains a noble pursuit, entrepreneurs have since discovered it is no easy feat to win the consumer palate. Alternative protein companies today have entered treacherous territory. The economy is uncertain, venture capital is down, and products are facing increased headwinds from consumers, who demand better taste, price and nutrition. Navigating this environment will require deeper focus (and some luck, too). So, to better manage the risks and achieve desired results, it’s worth understanding the challenges these companies face so they can be mitigated, and the visionaries behind them can reach ever greater heights. Six risks stand out. We consider each of them below.
#1: Technology Risk
To do things better requires innovation, whether in process, product or positioning. Companies that have an underlying technology which gives them an unfair advantage can more easily penetrate an increasingly competitive market. Therefore, as a company emerges with a technology, either owned, co-developed or licensed, we must ask two foundational questions:
(1) Does the core technology work?
(2) Is there defensible intellectual property (IP)?
Assuming the core technology produces the desired result, a company may choose to file a patent for offensive and/or defensive reasons or bypass the process altogether. At a minimum, the founders must ensure they have the freedom to operate, and better yet, create a competitive moat using their technology.
#2: Product Risk
For many companies in the sector, a pathway to ‘price parity’ is filled with hurdles and uncertainties. Both for ingredients and consumer products, it may instead be better to strive towards ‘price efficiency’, which we define as a price that is satisfactory to a segment of customers. This can be achieved in several ways:
Offering an ingredient with superior functionality (e.g. cultivated fat)
Targeting a more affluent consumer segment (e.g. with caviar or foie gras)
Creating hybrid or blended products with unique taste and nutrition (e.g. cultivated & plant-based)
Starting with premium offerings followed by lower-priced mass-market versions (e.g. Impossible Foods)
Two key questions emerge:
(3) Is it possible to reach price efficiency?
(4) Are the unit economics favourable?
Favourable unit economics is foundational for supporting healthy gross profit margins at scale. Unfortunately, it is particularly challenging to ascertain at an early stage of the company’s development and may require technology breakthroughs or orders of magnitude higher scalability than the company has accomplished to date, not to mention the additional capital expenditures that go along with it. A Techno-Economic Analysis (TEA) can help create a deeper understanding of the unit economics and address investor concerns.
#3: Market Risk
New products in the sector can have varying functionality, price, and regulatory requirements. In many cases, no such offering was previously available. Two key questions emerge:
(5) Is there a large market for the product?
(6) Are there pathways to penetrate the market?
When Beyond Meat launched its first burger designed to emulate conventional meat, it likely had little understanding of the target market or customer interest. However, the team understood that the conventional meat industry was over a trillion dollars in size and there was an opportunity for disruption for reasons spanning human health, animal welfare, climate change, and sustainability. Since then, many alternative products have emerged, providing startups today significantly more data and insight, which can be utilized to gain a better understanding of the addressable market.
Food is a crowded market with slim margins. Consumer companies look to channels such as direct-to-consumer, retail, food service and other strategies to reach their target audience. Companies operating in the supply chain can explore channels such as B2B sales, joint ventures and licensing opportunities. A company must demonstrate it can reach the market, particularly with early adopters who typically must absorb higher costs given the de minimis scale of the company in its early years. For example, Oatly led the charge for the rapid rise in popularity of oat milk, initially in the U.S. and Europe. As the company expands to other markets, factors such as existing alternatives, price sensitivity, flavour palates, and cultural nuances become important considerations.
#4: Team Risk
It is hard to overstate the potential of a team that is highly motivated to realize its vision. Therefore, this naturally garners substantial attention from investors during the diligence process. Teams have highly varied reasons behind their decision to start a company. They come together in different ways, sometimes solely to start a company, or in other cases, they may have a long shared history. However the team coalesces, there are two key questions:
(7) Is the team driven to succeed?
(8) Is the team structured well?
In this sector, it is not uncommon to see a founding team composed entirely of scientists. How will they structure their organization, define their roles, and complement their skillsets with other essential functions such as strategy, operations and commercialization? There must be a balance of ownership within the founding team and a plan to attract and compensate new team members, particularly leaders who will play a key role in the company’s future development.
#5: Funding Risk
Building food companies is challenging on many levels. In addition to science and product development, companies must deal with manufacturing, scale-up, inventory management, packaging, logistics, distribution, safety and regulation. All of this requires capital. Companies can tap equity, debt, and non-dilutive capital, all of which must be balanced to create an ideal mix – the right money at the right time. This leads to two questions:
(9) Can the company access capital?
(10) Is the company capital efficient?
The sector is early in its development, and founders are using varied techniques to attract capital. Unfortunately, this can wreak havoc on the company’s ownership structure, which then requires financial engineering to fix. Companies that win will utilize simple, straightforward, ‘vanilla’ fundraising strategies and remain conservative in both raising and utilizing capital. Companies with high burn rates, or those who have not adequately considered the cost of scale-up and commercialization, may find the fundraising environment and valuation discussions increasingly challenging.
#6: Regulatory Risk
Underpinning the alternative protein sector are three technology stacks – plant-based, fermentation and cultivated – with new technologies emerging. As product innovation is happening globally, regulation becomes especially intricate when we mix both technologies and regions. Based on the company’s product and target market, two key questions arise:
(11) Are there significant regulatory hurdles?
(12) Can the company meet regulatory requirements?
Whether it’s novel ingredients, GMOs or cultivated meat, a company must find an efficient path to access its target market(s). With uncertain timelines for regulatory approval, it must be well capitalized for such contingencies. It is readily evident when a company has developed a detailed strategy and obtained early validation for its approach, whether by engaging with experts or working with regulators.
From Risk to Reward
Anything done well takes sustained time and effort. Companies in this sector are conceiving products never seen before with the intention to upend large markets and create a better world for generations to come. Producing a clear, effective answer to each of the 12 questions across six categories of risk requires intense effort, ongoing trial and error and successfully tackling new challenges at each stage of a company’s development.
These 12 questions can be linked together into a chain of sorts, which is only as strong as its weakest link. The risks these companies face are both formidable and diverse, but every worthwhile pursuit tends to involve a (huge) measure of risk. As 2023 comes to a close, we salute the founders of companies that contend with these risks every day. We call out risks so that we can mitigate them, and create better products and companies as a result. Efforts create results, which deliver outcomes, that shape a better future. We’re on our way.
As this will be our last article of 2023, we want to thank you for reading Good Signal and wish you happy holidays! It has been our pleasure to be connected with you in our journey to distil insights from the sector.
These 12 questions are very helpful!