Using Debt and/or Equity to Fund Growth
Agriculture is big money no matter what part of the supply chain you operate in. Land, equipment, buildings, storage, transportation, packaging, and retailing all require a tremendous amount of financial capital. Land can go for as high as $7,500 per acre (some even more), a large tractor can cost $80,000 and a combine is just crazy! Specialized sorting, grading and packaging equipment setups cost millions to configure and setup. If you are going to operate a large operation of any kind it takes resources beyond the capacity of most single owner organizations.
Yet, the small operator can still play the agriculture game if done correctly. Not every product or service needs to break the bank to provide a realistic income for the right person. Within in the distribution chain a lot of support activities are required to make everything happen. Even small farm enterprises can do well if they find a niche market and can capitalize on a segment that seeks a unique product or service.
So what happens if you are in between -not a large operation, but still need money? Most single owner or family enterprises seek to borrow money to expand. Borrowed money (Debt) typically comes from a bank or the Farm Credit System. Monthly or seasonal payments are made and at the end of the term the land or equipment is owned by the entity. This is the way the vast majority of small to medium sized operations prefer to operate. Why is this so commonplace? Agriculture business people by in large are a pretty independent bunch. They are willing to work the hours needed to get the job done and prefer to work out solutions on their own terms. At the end of the day, they want to be sole owners of the operation and to be able to pass it along to the next generation.
While this goal of independent ownership is a strong American tradition it saddles many agriculture enterprises with a debt load that is hard to work out from under. If times are tough, the interest on this debt can be more than the enterprise can handle.
Is equity participation a better alternative for agribusiness? Corporations have investors that invest their money in a business for a shared ownership in the organization. Ownership is held by the stockholders of the corporation and these shares can be bought, sold and traded. They receive dividends from the profits of the business. Corporations can be small or very large depending on the amount of money invested and the profits made. Some small family farms have chosen to incorporate to make succession planning easier and to accommodate non-active membership. These are closed corporations restricting who can own shares. Other agribusinesses have sought outside investors that are purchasing shares in the hope of profit sharing and the increased value of the shares owned. Some of these corporations are huge with billions of dollars in reported income.
The idea of incorporating and taking on equity investors goes against the independent nature of many agribusiness people. Answering to a board of directors and having to get a conscience opinion on every decision is not particularly attractive to many in agriculture. Yet, corporations have a strong place in American agriculture and are becoming an attractive option for many wanting to fund the purchase of land and equipment costing millions of dollars.
Debt or Equity – which is better?
The answer may depend on what segment of the business you are in and the amount of money you need to raise. Land, buildings and most equipment usually acts as the collateral for a loan. While you are not likely to be able to finance 100%, funding for capital purchases is available for an enterprise with a good track record and some reserves. Operating capital; the money needed to buy fuel, hire seasonal labor and pay utilities doesn’t have the same collateral strength. You will find it difficult to finance operating expenses with borrowed money unless additional collateral can be pledged. For startups and expansions, the required capital reserves may not be enough to carry the operation until cash flow increases. In these situations other forms of financing are needed.
Thus you will find that many agribusinesses are a combination of debt and equity. Land, buildings and equipment can be borrowed money; operating expenses are best funded through invested money or strategic alliances.