Is your farm business investment ready?

There continues to be a need for alternatives to traditional farm business structures which enhance the prospects of obtaining external capital so that reliance on bank debt finance is reduced.

The October 2016 review of farm funding models and business structures by the Australian Farm Institute (AFI) highlighted the growth in bank debt finance from A$10 billion in 1990 to today’s figure of A$60 billion. While the increase in total debt seems alarming the review also found that the rate of increase is on par with the rest of the economy and that debt serviceability and equity levels have been relatively stable.

It must be remembered however, that this increase in debt has occurred in an environment of historically low interest rates and since the end of the millennium drought, generally good seasonal conditions and high commodity prices. There remains a wariness amongst farmers and financiers alike that a return to high interest rates or a run of bad seasonal conditions would severely test the sustainability of the debt that has been accumulated.

Fund managers and capital raisers report that there is no shortage of appetite for capital to be placed in agriculture and that there is wide appreciation of the desirability of agriculture as an investment sector. This suggests it should be easy to replace or compliment bank debt with alternative capital, in the form of equity investment. Unfortunately, the reality is that very few Australian farm businesses understand what it means to be investment ready and this is severely limiting the flow of equity capital into the farm sector.

The AFI review referenced a BDO survey of superannuation fund managers which asked for the reasons why only 0.3% of Australian superannuation funds are invested in the agriculture sector. The survey found that the primary reason for lack of investment in agriculture was the lack of investable products, but what does this mean?

Garry Edwards (AAM Investment Group), in his presentation on investment in Australian agriculture at the AFI’s 2016 Agriculture Roundtable Conference, talked about the necessity to establish the ‘terms of the divorce before any marriage is entered into.’ Garry was referring to the desire of corporate investors to understand how they can exit investments before they make a commitment to invest. This is a challenging concept for most family farming businesses.

Figure 1: Australian agricultural business structures compared to the average for all Australian businesses.

Source:  ATO taxation statistics (2012–13).

Figure 1 shows that Australian agricultural businesses have a disproportionately high number of partnerships and low number of company structures compared to the rest of the economy. There are real and practical reasons for this being the case. Partnerships provide stable, long-term structures that have a degree of flexibility and are suited to the extreme unpredictability of the Australian agricultural business environment. Farm business partnerships with high equity levels and spare borrowing capacity have been able to cope with long periods of drought and low returns while waiting patiently for better conditions to build equity. This is a formula that has worked for families who have no intention of leaving their businesses or setting up structures that make it easier to exit.

Traditional farm business structures may create stability and security however that can also lead to a lack of clear focus on the real profit drivers and risks associated with the business. The BDO survey found that a lack of competent asset managers was an impediment to agricultural investment and one of Garry Edward’s key investment criteria is a counterparty that truly understands their business and its risks. Businesses that are investment ready should have a deep understanding of how profits are generated and be able to model the impact of entry and exit of external capital under a range of production scenarios.

It seems ironic, but having a clear exit path is just as important as having an attractive, well managed and profitable business for potential investors in Australian agriculture. This will be a significant cultural challenge for farm businesses as much as it will be a business challenge.

Image:  Hayley Becker