Alternative Financial/Organizational Structures: How Should I Organize and Finance My Farm Business?

Alternative Financial/Organizational Structures: How Should I Organize and

Finance My Farm Business?

Objectives

• Identify criteria for choosing a financial/organizational structure

• Describe the options– Legal organization– Business arrangement– Leasing options– Equity– debt

Financial/Organizational Structure of the Farm Firm: Choices and Options

• Legal organization• Business arrangement• Leasing options• Equity• Debt

Financial/Organizational Structure Alternatives

Legal Organization

Business Arrangement

Leasing Options Equity Debt

•Sole proprietorship•Partnership•Corporation•Land trust•Cooperative

•Independent•Contract•Subcontractor•Joint venture•Franchise•Licensing

•Real estate lease•Facility/equipment•Capital/fin-ancial•Leveraged•Sale-Leasebacks

•Sources–Initial capital contributions–Retained earnings–Stock–External equity

•Business Practices

–Payout policy–Family transfers

•Loans–Maturity–Interest rate–Amortization arrangements–Collateral–Conversions

•Bonds–Convertible–Callable–Zero coupon

Criteria for Choice

• Control• Returns• Risk• Maturity/permanence/liquidity

Organizational Structure and ROELeverage

Ownership 26% 50% 70%Mix of rent, Mean 17.0% 20.1% 24.9%

share, own Std. Dev.

5.3% 7.1% 10.0%

All owned Mean 9.9% 10.7% 12.3%

Std. Dev.

2.4% 3.5% 5.5%

Rent Mean 25.6% 30.7% 37.9%

$110/acre Std. Dev.

11.8% 15.2% 20.0%

Share Mean 20.3% 23.9% 28.9%

(50/50) Std. Dev.

5.8% 7.5% 9.8%

Financial Performance of Pork Production Units

Financial Structure

0% Debt 40% Debt 80% Debt

Pork Production Business Arrangement

Mean Return on

Equity (%)

Prob-ability

of Default

Mean Return

on Equity

(%)

Prob-ability

of Defaul

t

Mean Return

on Equity

(%)

Prob-ability

of Defaul

t

Independent farrow to finish

17.0 0.0 23.5 0.05 56.5 0.26

Efficiency and marketing incentive contract

10.4 0.0 12.5 0.00 23.1 0.33

Death loss incentive only finishing contract

11.3 0.0 14.0 0.00 27.6 0.11

Legal Organization

• Sole proprietorship• Partnership– General– Limited

• Corporation– Regular– Subchapter S

Legal Organization

• Limited liability company• Land trust• Cooperative

Business Arrangement

• Independent producer• Contract producer• Subcontractor• Joint venture• Strategic alliance• Franchise agreement• Licensing

Contracting Options

• Marketing agreements• Profit/Loss sharing• Profit/Loss sharing with provided resources• Flat fee plus efficiency bonuses

What Do End Users Want From Producers?

• Cost competitiveness• Consistent quality• Timely delivery• Predictability/reliability• Flexibility/adaptability• A qualified supplier

What Do Producers Want From End Users?

• Equitable reward and risk allocation • market presence/position• Dependability• Access to innovation– products– markets– technologies

Types of Networks:

• Information networks

• Marketing networks

• Production networks

Benefits of Networking

• Capture proven technology• Capture real economies• Improve product quality and market access• Utilize production, marketing, and information

systems

Limitations of Networking

• Commitment of people• Joint responsibility• Formal business procedures• Loss of markets and suppliers

Networking Questions:

1. Who to partner with?2. How do I identify?3. How to negotiate?4. How to govern?5. How to manage?6. How to finance?7. How to exit?

Leasing Options

Real Estate Lease– Cash lease– Share lease– Flexible cash base– Shared appreciation lease

Leasing Options

• Facility/Equipment operating lease• Capital/Financial lease• Leveraged lease• Leaseback

Equity

Sources– Initial capital contributions– Retained earnings– Valuation Equity– Stock

• common stock• preferred stock

– “External” equity/contributions– Warrants or options– Venture capital

Equity

Business Practices– Payout (dividend or withdrawal) policy– Intrafamily transfers– ESOPs and stock options– “Buyout” policies

Debt

Loans– Maturity– Interest rate– Amortization arrangements– Prepayment features– Security/collateral– Conversion of terms

Debt

Loans– Shared appreciation mortgages– Reverse mortgages– Interest rate strips, futures, options, swaps

Debt

Bonds– Convertible bonds– Callable bonds– “Zero coupon” or deep discount bonds

Conclusions – Financial/Organizational Structure

• Critical strategic decisions• Significant impact on ROE• Numerous alternatives• Diversification

Strategic Business Planning for Commercial Producers