The rapidly growing food technology industry faces unique technical accounting challenges.
By Will Tanem, Partner, Advisory
Food tech holds the promise of solving some of our planet’s biggest challenges. With human populations exponentially growing around the globe, emerging technologies that increase agricultural productivity and that increase the efficiency of land and resources will be key to feeding the additional 2 billion mouths we will need to feed over the next 30 years. Science that improves the shelf stability of that food will represent an important safety valve as climate change and all-out climate disasters threaten top food-growing regions, like California. And plant-based meat substitutes, and if we’re lucky, lab-grown meat, will be critical to ending our dependence on livestock farming, which is increasingly being recognized as a major contributor to climate change. The food tech industry consists largely of businesses attempting to productize and scale technologies like these and make them cost-effective. It’s no surprise then, that the food tech market is predicted to grow at a rate of 6% each year between 2019 and 2027.
All this growth does come with certain challenges, however. As food tech startups grow rapidly to meet demand, so do the complexities of managing a changing organization. These challenges include acquiring equipment, navigating supply chains, finding talent, maintaining employee engagement and company culture, coping with increased scrutiny from regulators, and our topic today, highly technical accounting complexities impacting timely financial reporting and potential fundraising and exit scenarios. As these companies grow, investors and founders alike have newfound appreciation for financial reporting as the ability to produce timely audited financial statements can make or break an entity’s fundraising plans.
Food Tech Technical Accounting Challenges: Revenue Recognition
Ultimately, the end product for a food tech business is a consumer product, so one might think recognizing revenue would be a simple task. It is not.The food technology sector has always been a bit of an anomaly in the accounting space because it straddles a line between multiple industries and does not fall in one convenient “bucket” when it comes to accounting practices. A company may sell a protein extract as a resource for other food tech companies to use in their products, making them a raw materials distributor. Further, if they’ve formulated their own finished product, they’re suddenly a food manufacturer. Companies in the food manufacturing space then have their own complexities as they sell to grocery stores and distributors. Each step along the way poses unique challenges for how the company recognizes revenue.
As this industry grows in size and stature, companies are repeatedly coming to the conclusion that certain technical accounting projects are required, most of which require expertise outside of the typical in-house accounting team to solve. To illustrate why that’s the case, let’s evaluate a couple of key revenue recognition issues emerging companies in this industry are facing:
- Volume Discounts:Food tech companies that have material supply agreements often have to negotiate deals with volume discounts based upon forecast sales of material supplies and consumer demands. Depending on how the discounts are structured, there are variable elements that for accounting purposes companies often must estimate at the inception of the contract to determine the expected fair value of a product that may change in price over time. Further, a future discount could require an entity to account for a material right if the discount is lower than their standard estimated selling prices when sold to other third parties. These arrangements are incredibly complex and require specialized accounting knowledge.
- Slotting Fees:These are charges that food manufacturing companies typically pay to obtain shelf space for a product in retail stores. Obtaining shelf space in this manner is a sales and marketing strategy that many companies with new food products, including mature food tech businesses, follow to drum up awareness and recognition of their product. The accounting challenge is that these fees are generally not tied to any promises for the retailer to buy a certain quantity of a product and often do not cover a contractual-committed period of time. These fees must thus be assessed to determine whether they represent a distinct service being received. Commonly, they do not, which means companies must reduce their revenue accordingly by these fees at inception or over the period of time to which the benefit relates. Moreover, mature food tech companies often enter into numerous unique forms of these slotting arrangements with multiple retailers, thus multiplying the complexity as the accounting is not a one-size fits all.
Food Tech Technical Accounting Challenges: Licensing
The heavy R&D required upfront to mass produce food tech products means that early-stage food tech companies — i.e., those in the process of conducting research and developing new alternative proteins — are essentially life sciences companies, and actually have far more in common with the biotech industry than they do with the agriculture sector. So far we’ve talked about the challenges that food tech businesses face with regard to revenue recognition. But there’s another area that presents obstacles to accurate accounting and that’s licensing arrangements.
Unlike traditional agriculture, food tech licensing agreements are comparable to those of the life science vertical, as often these companies will acquire intellectual property such as licenses and patents to apply to their technology during R&D activities aimed at creating new food products. These arrangements generally require an accounting analysis to determine whether they constitute purchasing a business or an asset acquisition. These deals may contain non-cash payment terms involving equity exchanges of warrants or other instruments, which can add layers of accounting complexities for consumer product organizations that are not familiar with life science industry-specific accounting transactions and often require a third-party valuation expert. Accounting for this correctly is nevertheless essential to paint an accurate, compliant picture of the financial state of the business.
Bring on the Experts.
As these examples illustrate, even experienced CPAs tend to lack the kind of specialized knowledge required to conduct these sorts of analyses. For food tech companies, the best time to bring in the aid of a technical accountant is generally “the sooner, the better.” Companies that wait until after reaching a major milestone have generally waited too long as executive teams expecting a quick turnaround of audited financial statements to provide investors would be severely disappointed. Instead, hiring a technical accounting expert early in the process will help make sure that your records and finances are in order when you take the next big step.If you’re a food tech company decision maker, let’s talk. Get in touch withWill Tanem, Partner and Leader of our Technical Accounting Practice, today to find out how BPM can support your business’s technical accounting needs.
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