By Annie Gasparro
When General Mills Inc. and Kellogg Co. couldn't beat the startups appearing on store shelves next to their Yoplait yogurt and Froot Loops cereal, they decided to invest in them.
Food giants are starting venture-capital funds to invest in startups focused on healthier and less-processed foods, betting the younger companies can teach them to be more entrepreneurial and innovative. Slow to recognize consumers' shift toward those products, global titans have found themselves stuck in a rut. This week, Nestlé SA, the world's largest packaged-food company, dropped its long-running sales-growth target for the next three years, saying it needs time to adapt to these fundamental changes in the industry.
"It's hard for consumer companies to step out of what they've been locked into for 60 or 80 years," said Ryan Caldbeck, founder and chief executive of CircleUp, a business that connects private-equity firms with food startups. CircleUp says large consumer-goods companies lost $18 billion in market share to smaller competitors between 2011 and 2015.
In January Kellogg's fund, Eighteen94 Capital led a $4.2 million investment in Kuli Kuli, which makes snacks with moringa, a leafy green tree common in Asia, Latin America and Africa. A week later, General Mills' venture-capital fund, 301 Inc., made a second investment of $6 million in Rhythm Superfoods, maker of "zesty nacho"-flavored kale chips.
Campbell Soup Co. and Tyson Foods Inc. dedicated $125 million and $150 million, respectively, toward their in-house venture funds last year.
In total, venture capital funds made 66 food-and-beverage-related deals last year, up 20% from 2015. About a fifth were backed by big food companies, according to Dow Jones Venturesource.
Because food giants and emerging brands are also competitors, some entrepreneurs have been wary of entreaties from these investors.
"If I tell you all our trade secrets, what's going to stop Kellogg from making their own moringa bar?" Kuli Kuli founder Lisa Curtis recalls asking Simon Burton, the head of Kellogg's venture capital fund.
Mr. Burton acknowledges that Kellogg is looking for marketing and recipe ideas that can help improve the performance of its older brands like Nutri-Grain bars and Chex Mix. "We're looking for a mutual benefit on top of the return on investment," he said.
Ms. Curtis said access to Kellogg's resources and reach in the industry made that partnership worth it. "The deal gave us validation," said the 29-year-old former Peace Corps volunteer.
Rhythm Superfoods Chief Executive Scott Jensen said many of his peers are more open to a minority investment than a full acquisition. Some have heard cautionary tales of startups that slipped after teaming with big food makers, like Kellogg's rocky pairing with cereal-maker Kashi. A few years into its ownership, Kellogg merged Kashi with its broader operations, and the once ahead-of-the-curve brand began falling behind on innovation.
Mr. Jensen first met General Mills executives at a Fancy Food Show in San Francisco in January 2015. A year later, General Mills led a $3 million investment in his kale chip company. He said he has benefitted from resources such as General Mills' array of specialists, like an engineer who works only on bagging machines.
Rhythm's sales rose 30% in 2016. Mr. Jensen expects sales to rise another 40% this year to more than $20 million. But General Mills isn't "telling us how to run our business. And now that other people can see that, I have a lot of people who come to me and say, 'Can you introduce me to them?'"
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