Cultivator is our farmer incubator program and right now have ten of Australia’s best aspiring farmers getting the resources to pitch to farm investors.
Each month we work together to develop their farm investor pitch document. During May, we are preparing a five-year financial model to demonstrate to the investor that they are farm ready.
P2P Agri is the powerful software we are providing to the Cultivators to forecast their farm business profitability and demonstrate their risk mitigation, using real farm situations. Mike is the director and founder of this powerful financial farm management software. He is one of the incredible mentors that each of the Cultivator participants receives one one one coaching.
Mike kindly responded to some questions about farm management in a Cultivator webinar and the content was so good we thought you would get value from it too!
How do I create a lease and share farm agreement?
Most agreements for leasing land and share farming are not written down. They are generally done with a ‘handshake’. These types of arrangements are fine, so long as no disagreements.
It is far better to have an agreement where the agreed payments, time of payments and a dispute resolution process are determined prior to any disagreement. This allows for a better relationship through the ups and downs of seasons.
You can either obtain:
• a legal agreement, which means engaging a lawyer to draft the agreement, or
• a non-binding agreement drawn up and agreed to by both parties.
There is less legal protection in a ‘non-binding’ agreement when there is a disagreement.
Several agreement templates are available on the web, such as the one listed below:
As there is no given formula to guide the setting of a lease or a share farming agreement, there are a wide variety of agreements in the rural industry. Essentially, the agreement comes through a negotiation process. Guides can be taken from other similar agreements completed in the district.
P2PAgri does account for lease and share farming payments. The estimated financial outcome of any agreement can be modelled to see what the effect is on the business through a range of seasons. This assessment should be used before any final agreement is made.
How do we go about buying the equity from the investor?
The process of the investor selling equity is essentially by negotiation between the investor and entrepreneur. Again, you would be advised to have an agreed payment process written down to protect both the investor and entrepreneur. This agreement should outline:
• What the equity value that is being bought back over time will be, as asset values do change over time.
• When the payments are made.
• What each payment should be and how much equity this represents.
Essentially, the entrepreneur’s profits can be used to buy portions of the investor’s equity over time.
What is the ‘sweet’ spot for scale?
This is a difficult and very challenging question to answer! It largely depends on the capital available to establish the agricultural venture and how that capital will be used. That is the mix of land, water rights, machinery and livestock.
The best way to start looking at this is to observe the successful farming businesses in the district and see what areas, labour, water rights and livestock they manage. Just beware a successful farm does not necessarily have the ‘white picket fence out the front’.
The next question to answer is to determine the most limiting resource to the project. Is it capital, usually represented by land, or is it labour? Determine which is the resource (land or labour) is most limiting and look to maximise the efficiency of that resource. Also, keep in mind efficiencies of scale.
I suggest you get your base project modelled in P2PAgri and then use SCENARIO Analysis to assess different sizes of that project.
How do I organise an investor agreement?
Again, investor agreements can be quite varied between projects and come down to negotiation. I suspect Cultivate Farms have a template you could start with.
How do we account for the development part of the project?
If you have a development period for your project, such as you need to build a cattle herd or develop land with improved pasture, you will need to have a projected Cash Flow, Management Profit and Loss, and Balance Sheet estimated over time. This should indicate the initial capital costs and how productivity and livestock numbers will build over time. P2PAgri is a great tool to help you do this.
How do we demonstrate progress?
When you think through your project, you should be able to develop milestones with targeted deadline dates. This can be in the form of financial goals, but can also be physical, like the number of sheep in the enterprise. As you achieve these milestones, you will be demonstrating achievement both to yourself and your investor.
What interest rate should we pay the investor?
This is negotiable and depends on the degree of risk in your project. Also, if land is being purchased, then the projection of the asset growth in that land value could also have an influence on the investor’s attitude to reward. As a rule, the higher the risk, the greater the reward and so the investor will be looking for higher returns.
At the moment, the alternative use of capital by depositing in banks gives a very low reward. Bank interest rates are now the lowest they have been in Australia. So, the opportunity costs of funds are low, and the investor’s expectations may also be lower. That is, if they do not invest in your project, the alternative is leaving it in the bank with low-interest rates. A starting point is to look at the bank deposit rates and add a margin for risk to help strike an agreed return to the investor.
What business models can we use?
There are traditional business models that traditional farms use where they look to own all their assets of land, machinery, livestock and water rights. Other business models might look at leasing or share farming some or all these assets. There is a large range of business models available to you. It needs your imagination, a list of your and your investor’s goals and some financial modelling to determine the best business model for your project. P2PAgri is an effective tool to model the different business models. You will also need to organise the legal structure needed to manage your business model.
Should I use debt or get investor equity?
The answer to this depends on your personal financial circumstances. A rule would be if you wish to personally gain the most wealth generation from your rural business then you retain as much equity as possible. However, this could restrict the size and economies of your business.
If you take on debt, then you need to maintain good communication with your bank to help manage the good and bad seasons. If you take on equity from an investor, then you need to manage your investor communication. As a rule, the bank will have stricter lending rules to adhere to than your investor. So, an investor should have more understanding and have expectations that allow for the good and bad seasons. Your bank may not have as much flexibility.