6 Farm ownership transition options

6 Farm ownership transition options

Cultivate Farms

We are often asked what farm transition options there are and we engaged our mate Andrew Bomm from Progressive Agriculture to summarise a handful of options to help you get a quick understanding of your options.


Options

There are several options available for aspiring farmers to manage land assets owned by others to build a sustainable farm business. They are: 

1. Leasing 

2. Share farming

3. Lease to buy options

4. Vendor finance

5. Collaborative farming

6. Joint venture/equity partnerships


Principles

Successfully starting or expanding a farm business requires an understanding of what drives farm business profitability and the business structures available to meet your objectives. 


Farm business growth can come from two separate areas:

1. Capital growth from land ownership

2. Profit from managing the operating farm business


Farmers at all stages of their business life should considering asset ownership and the operating business as two different farming enterprises. Doing so opens a range of options for exiting farm businesses and those wishing to start a farm business or expand their current operations. 


Most successful farm businesses have managed to leverage the value of their land assets to improve the scale, efficiency, and profits of the operating farm business. 


However, building this asset base can take a long time. Farm businesses that limit their scale to their current asset base are limiting opportunity for generating the profit necessary for purchasing land. Parcels of land are continually the subject of negotiation about managing business transition, either being re-distributed in succession planning processes or sold. These parcels can be available to capable young operators who:

* demonstrate a business case that they can run the land profitably; and

* use the most suitable business structures to access it. 


Leasing 

Leasing land provides a good opportunity for new farm businesses to generate profits that can then be used to fund land acquisition. 


Historically, lessors (landlords) have sought annual lease payments of around five per cent the value of their assets. However, this arrangement is difficult to make work for two reasons:

a) Increasing land prices have often made this rate unaffordable, relative to what can be made from production off that land. 

b) A flat rate means that lessees (tenants) bear all seasonal and production risk, with landowners collecting the same lease payments regardless of what weather and prices are doing.


An alternative is a flex lease arrangement, where lease payments fluctuate depending on the drivers of profit, usually price and seasonal conditions. In many instances, these types of leases involve a base lease rate (eg two per cent of asset value), plus a proportion of operating profit from activities carried out on that land (see share farming below). 


Another option is to negotiate lease payments based on the productive capacity and potential operating profits that can be made. For instance, calculating land DSEs and reaching a lease agreement that provides a realistic opportunity for both parties to share a reasonable return from the asset. This is a good option where land values have risen significantly beyond typical operating returns from that asset. 


Whichever option is taken, it is critical that parties enter into a written agreement reached only after:

* Doing a detailed budget to assess returns relative to cost.

* Seeking professional legal advice. 


Example:

Brothers Jeremy and Brendan have taken over their parents’ 600 ha mixed dryland cropping and livestock operation in the Victorian Mallee, with average 400mm per year winter dominant rainfall. They are both skilled farmers with university education.


Jeremy and Brendan’s machinery and labour are not being efficiently at current scale used so they decide to negotiate a lease on a nearby 400 ha block that hasn’t been renewed by the previous lessee. Recent land price increases mean they can’t justify lease payments equivalent to five per cent of the asset value. They negotiate a five-year lease based on the cropping and livestock production capacity of the property using their intended mix of enterprises and production system. 


If they face poor seasonal conditions for the next two years, they have sufficient equity in their business to meet lease payments. Jeremy and Brendan have budgeted for profit on the deal with two average-to-good seasons during the five-year lease period. 


Benefits

* Opportunity to access land without needing the equity to purchase it

* Can increase the scale of an existing farm business, improving efficient use of overheads such as machinery and labour


Drawbacks

* Traditional lease arrangements place risk of poor seasons and prices on the lessee

* Expectations of returns as a proportion of asset value can be unreasonable

* Incentives to maintain and improve soil and infrastructure can be unclear, leading to reduced productivity


Share farming

These arrangements distribute profits from agricultural production between landowner and farm operator, based on who bears costs of production and risk. Share farming has similarities with flex lease arrangements, because both farm operator and landowner share seasonal and price risks farm businesses face. In reaching this agreement, the opportunity cost for the landowner of not leasing the land for a flat rate should be accounted for. 


This is a better way of aligning risk and reward than a straight lease, but can lead to disagreements about who should be paying for certain costs unless the agreement is clear and well understood. This is particularly the case where soil health, weed control and infrastructure maintenance or upgrades are involved. These activities not only have a benefit for productivity and annual profit in the short term, but also for longer-term productivity beyond the life of the agreement, as well as underpinning the capital value of the property. 


Share farmers are often reluctant to make these costly investments if the returns can’t be captured beyond the current agreement and only the landowner captures the benefit of capital growth. These issues need to be well understood before such agreements 


Example:

Greg and Sue run a 300 ha irrigated cereal cropping and livestock business in the Murrumbidgee Irrigation Area. Their elderly neighbours have a similar size block and would like to remain there, but can’t actively farm the block any longer.


Access to this additional land would improve Greg and Sue’s efficient use of machinery and labour inputs so they approach their neighbours to enter a share farming agreement. A major hurdle to an agreement is the need for new irrigation layouts to minimise water costs by improving water use efficiency. This will have long term productivity benefits and improve the chances of their neighbours selling the property for a good price when they want to leave.


An agreement is reached in two parts. Firstly, each party contributes 50 per cent of the costs of seed, fertilizer and herbicide, Greg and Sue provide labour and machinery costs, and their neighbours use of the land. Profits are split equally. Secondly, an agreement is reached to upgrade irrigation layouts via an upfront contribution from the landowners, which is offset by Greg and Sue paying back a percentage of this cost for each year the share farming agreement lasts, to an agreed cap. 


Benefits

* Farming risks shared between farm operator and landowner

* Opportunity to access land without needing the equity to purchase it

* Can increase the scale of an existing farm business, improving efficient use of overheads such as machinery and labour


Drawbacks 

* Potential for conflict over which party pays for certain costs 

* Difficult to reach agreement where costs bring long term productivity or capital growth benefits 

* With both parties sharing profit, management strategy can be a source of disagreement 


GRDC has provided a very good fact sheet on leasing and share farming: https://grdc.com.au/…/leasing-and-share… 


Lease to buy options 

Negotiating an option for the lessee to buy the land at the end of a lease agreement can be a good way to manage the transition of land ownership between farm businesses that are winding up, to those starting or expanding. The option to buy can be at a sale price reflecting an agreed rate of capital growth over the period, with the lessee building equity from business profit during the lease period to fund purchasing the property when the lease ends. 


For the landowner, this arrangement provides a clear pathway to liquidating their asset. Knowing the purchaser, they can potentially negotiate continuing use of their family home if that suits both parties. 


Most importantly, this arrangement helps remove conflict about who pays for on-farm upgrades that boost productivity and improve capital value. Lessees can be more comfortable making these investments on the farm knowing they can capture capital growth above the agreed sale price. Landowners can enter the lease agreement knowing they won’t be faced with unexpected expenditure requests. 

However, parties need to be aware that capital values can shift unexpectedly, so they should consider how to distribute windfalls or losses fairly if actual values are significantly more or less than the anticipated value of the land at the end of the lease. 


Example: 

The Morrison Farm Company would like to farm a retiring neighbour’s property into the future, but have bought another property recently and don’t want exposure to the additional debt at this time. They negotiate a rolling five-year lease arrangement where they may, at the end of a lease term, acquire the property for a price negotiated at the beginning of the lease period. 


They don’t choose to purchase the property at the end of the first five-year lease period, instead re-negotiating another five-year lease at 4.5 per cent of the appraised land value. Using this appraised value ($800,000), they negotiate an option to buy at a price reflecting four per cent annual capital growth over the five-year period ($973,000). 

Following good seasons and an improvement in the businesses’ equity position, they purchase the block at the end of the lease. They have spent $80,000 on improvements during the lease, taking their investment to $1.053 million. However, by investing in improvements and maintenance, combined with strong capital growth in the district, the appraised value is $1.1-$1.2 million. 


Benefits

* Can help manage land ownership transition between farm businesses

* Provides incentives for potential new landowners to make long term investments in productivity improvements

* Exiting landowners can manage succession planning more effectively 


Drawbacks 

* Landowners may be reluctant to commit to selling at a fixed price in future, and forgoing the benefits of rapid increases in land values. 

* Lessees run the risk of investing in the property and not being able to afford the option to buy at conclusion of lease


Vendor finance 

Vendor finance describes the arrangement where a farm purchaser pays a deposit to the landowner to acquire the property, and the seller lends the rest of the money, which the purchaser agrees to pay back at an agreed rate. This enables the buyer to access land, and provides the exiting farmer to continue to receive a consistent return. 


For vendor finance, the borrower will generally need to pay a higher rate of interest than if deemed safe enough to obtain bank finance.


Also, property loans are generally for long periods, and it may not suit the vendor to have their money tied up for a long time, in which case the buyer is going to need to be able to access bank debt after a shorter period than a traditional loan. 


Example: 

Dan is an aspiring farmer who has been working on John and Debbie’s berry farm for the past three years. They have no children wanting to take on the farm and would like Dan to purchase the farm from them.


They negotiate a vendor financing arrangement where Dan purchases the farm with a ten per cent deposit and pays 5.5 per cent interest on the remaining balance. Dan has plans for niche market opportunities and considers that he can meet these interest costs. 

However, John and Debbie would like to receive all proceeds from the sale in ten years’ time to fund their retirement needs. The agreement includes terms that Dan needs to find bank or other finance by that time, or sell the property and pay his debt to John and Debbie. 


Benefits

* Allows new entrants to purchase land when bank debt is unavailable

* Provides exiting farmers with a return on their asset until they sell

* Purchaser can invest confidently in land improvements or diversification 


Drawbacks

* The interest rate paid on the loan will generally be more expensive than bank debt

* Vendors may not want their asset tied up in lending agreements for a long period


Collaborative farming

Collaborative farming describes an arrangement where two or more farming businesses pool resources and skills to improve scale and/or efficiency, improving profitability for each party. 


These arrangements work best when:

a) pooling resources achieves more efficient business scale; and

b) the complementary skills of each party improve overall business management. 

These arrangements can involve combining all land, people and other business other assets of two or more farm businesses within a single collaborative farming business. Or, it can include more selective options such as pooling machinery, infrastructure, labour or other business assets. 


A larger operating business can also be leveraged to access additional land through lease or share farming arrangements. 

Collaborative farming requires each business to give up some degree of control to be part of a larger, more efficient, and professionally managed farming operation. 


Example:

The Bulla Burra business in the Mallee region of South Australia is a successful collaborative farming venture, growing winter cereal and legume crops. Here, the original two farm businesses in the venture lease their land to a parent operating business they jointly own and operate. The operating business and land ownership are treated as separate enterprises. 


The operating business owns machinery and other non-land assets, and leases additional land from other landowners. Because each partner benefits from the profitability of the overall business, conflict about prioritising the performance one block over another are eliminated. 


One of the owners manages the business management aspects of the farm while the other focuses on the agronomic and operational side. Key strategic decisions are made under the guidance of an independent chairman. Complementary skill sets, and good decision-making processes, improves business capability and the quality of business decision-making. 


Benefits

* Ability to improve business scale and efficiency

* Improved decision making from complimentary skill sets 

* Improved business management systems 


Drawbacks 

* Loss of control for individual farmers

* Risk that relationships will break down and structures need to be unraveled 


Joint venture/equity partnerships

These arrangements involve the establishment of a corporate farming entity (often using trust arrangements), in which owners of the business have an equity stake as a shareholding in the business. Shareholders may be farm operators, landowners, off-farm family members, or external investors.


This structure allows a flexible approach to business management and ownership, particularly during periods of business transition. Profits from the operating business are either re-invested in the business or distributed to shareholders as dividends, while assets can either be owned or leased. Business operators are paid for their management role in the business, and via dividends if they are shareholders. 


A corporate structure with responsibility to shareholders encourages improved corporate governance and accountability for business performance. 

It enables the business to attract investors for increased scale, or investment in diversification or infrastructure. This opportunity will appeal to businesses who want to be more aggressive than bank debt will allow, or want to bring in skills or market access that investors can provide. 


The separation of ownership and management also allows for better succession planning arrangements. Assets don’t need to be sold and the business scale reduced during generational transitions, as non-farming shareholders can either continue to generate returns from their shareholding, or sell their shares to another party. 


Example: 

Richard and owns an irrigated cropping business that combines specialist management services with broadacre irrigated and dryland cropping. 


He would like to expand his cropping business by accessing additional irrigation country and diversify into farmed fish production. This strategy will improve efficiency of labour and machinery inputs, diversify market risk, and generate a more efficient use of his available water.


He finds an investor to invest as an equity partner, contributing funds to acquire a large additional irrigation property and build fish farm infrastructure. The investor also brings aquaculture expertise to ensure this enterprise is well managed.

Richard is paid a salary as operations manager and receives dividends from profits left over as a remaining 40 per cent shareholder. The new farm business entity engages a professional farm management company to manage financial reporting, governance and compliance requirements. 


Benefits

* A corporate structure improves governance and accountability

* Can attract investors as an alternative to bank debt

* Assists keep land assets intact during succession planning 

* Remunerating farm operators realistically prices costs of production 


Drawbacks

* Farm operators sacrifice some control over the business

* Investor shareholders may impose exit strategies that need to be prepared for

* Shareholder agreements may be poorly drafted, leading to conflict about business decision-making