The Recovering Accountant – Why debt service is the only thing holding up true 10X growth

Will the agriculture industry allow primary producers to become billion-dollar businesses?


In every industry, if you aren’t growing you are dying. This is no different in primary producer agriculture, even if we don’t like the sentiment. 


Most farms today that have trouble competing were either new entrants to the industry or made minimal growth projections over the last decade. The time to expand and grow was before the land appreciation cycle took off and now that we have made the current leaps and bounds it is going to get tough for those without old equity. Those of you who took the risk and are now reaping the rewards have a large advantage if you want it.


I have mentioned in other articles and podcasts that I believe one of the restraining forces in agriculture in the next decade will be access to capital


Agriculture is asset-based lending and as such the more land you have the easier it is to continue to have monumental growth. But as land values also escalate the true ceiling for most enterprises will become the ability to debt service. 


The opportunities will not slow down, but your ability to make enough profit from the acres to cover the high cost of expansion is going to start to decline. So how do we as progressive and growing farms not become complacent and stand still (which is ultimately going backwards with inflation)?


Debt Structure


The days of debt-free farming are no longer available for most producers. Not to say I don’t have a few clients that can make this claim, but the overall average is not going to hit this target. The actual question is whether they should. 


Returns on farms over the last few years have continued to be strong, whether through grain production or insurance. This has created large returns on equity much higher than even the current interest rate numbers we are seeing. 


Let’s brush off traditional business strategy, if your return is greater than your costs at what point do you borrow to grow? Is it a 5% return, is it 10%, or do you demand more to take on the risk? This will be individual based on the farm, but I know if I could go back in time what my answer would be on buying land.


A large majority of producers have never heard the term “debt restructure” unless it had a negative connotation. Until I started working at MNP, I would probably agree that it wasn’t something you ever really wanted to have to do. But now I know differently, having to and wanting to make the definition considerably different. I have very few farms that have not restructured to open potential for future growth.


A $1M loan over ten years at 5% equates to around $130K of payments per year. That same loan over thirty years equates to around $65K which is half the debt service of the first option. This means that by pushing out your debt over longer amortization periods in this example you could double your loan balance and thus double your purchase of land (or other assets). This is on a small scale, what happens when you do the same treatment over a farm that has $10M of debt or more. It has a considerable advantage in the ability to continue growth.


The other thing to keep in mind is equipment debt when it comes to structure. If you want to own your equipment and have equity in it then skip to the next point, but if you want to truly open additional room for expansion then why own a depreciating asset (every year will not be like the last two where inflation eliminated depreciation)? We have chosen to extend our equipment debt to keep debt service low and allow us to expand in other areas. This is a choice on our farm; you make your call.


Many will not agree with this type of debt restructuring as it does add considerable risk to the operation. However, risk and reward have a direct correlation and with growth you do assume risks. The goal is to make sure that your insurance or risk management planning puts you in a position to also mitigate those risks to an acceptable level.


Investment Alternatives


You can go into business with the banks, or you can go into business with the investors. They both have positives and they both have negatives so before you clearly identify a side I would think hard. 


By foregoing bank financing and using outside investment it often keeps your debt serviceability at a lower level as rent is considerably lower than current interest costs. You are giving up real estate appreciation, but this may be the lesser of two evils to control the land and still make “farming profits”. 


The part that many forget is that taking on investors may also provide you with the ability to continue growth on other parcels or with other investors. Many have a hard time not owning the land outright as you would with debt financing, but the ability to continue growth can also be an alluring alternative. Especially in times with $15 canola and $10 wheat to be grown on those additional acres. 


Farmers have always had a love for dirt, which sometimes makes decision-making more emotional than it should be and leads to the wrong solutions. One way of keeping debt service at an acceptable level is to look outside the box and include outside investment in your purchase decisions.


I have also seen numerous options where the outside investment was family members. Whether it was parents or siblings, or extended family in a total other industry looking for a safe investment, these options are available. I sometimes push back that business with family is more messy than outside investment but if the end profits are going to the same place (estate, family trust, etc) then this is also another strong alternative to control your debt service.


In the end, the debt service ratio is driven by profitability and debt requirements. 


If you increase profits, you make it stronger, if you decrease debt payments per year you make it stronger. How you achieve either goal is totally up to your strategy as a farm and how you go about operations. 


The recovering accountant in me would tell you to play safe and control your debt load to make sure profits can always cover servicing, but the advisor in me and the individual who has seen more progressive farms outgrow their competitors says risk leads to reward. And when you have other places and strategies to manage the risk you make the equation very one-sided towards reward.