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 OptionsEquityDebt Sole proprietorship Partnership Corporation Land trust Cooperative Independent Contract Subcontractor Joint venture Franchise Licensing Real estate lease Facility/equip ment 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 –Amortizati on arrangement s –Collateral –Conversion s Bonds –Convertibl e –Callable –Zero coupon

Criteria for Choice Control Returns Risk Maturity/permanence/liquidity

Organizational Structure and ROE Leverage Ownership 26%50%70% Mix of rent,Mean17.0%20.1%24.9% share, ownStd. Dev.5.3%7.1%10.0% All ownedMean9.9%10.7%12.3% Std. Dev.2.4%3.5%5.5% Rent Mean25.6%30.7%37.9% $110/acreStd. Dev.11.8%15.2%20.0% ShareMean20.3%23.9%28.9% (50/50)Std. Dev.5.8%7.5%9.8%

Financial Performance of Pork Production Units Financial Structure 0% Debt40% Debt80% Debt Pork Production Business Arrangement Mean Return on Equity (%) Prob- ability of Default Mean Return on Equity (%) Prob- ability of Default Mean Return on Equity (%) Prob- ability of Default Independent farrow to finish Efficiency and marketing incentive contract Death loss incentive only finishing contract

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