There is an old saying that "to get started in farming and ranching, you either have to inherit land from family, marry into it or be lucky enough to have a generous, rich neighbor gift it to you." It is tempting to look at successful producers who have a considerable amount of land and think that anyone could be successful with such a head start. Some producers who lack access to capital without land equity can become discouraged or frustrated. This is particularly true among young and beginning farmers.
What strategies can you employ when hard collateral, such as land, is not available? How can an individual build a case for financing when their collateral consists of soft assets, such as equipment, machinery, inventory or management potential?
The answer may start with intellectual capital, which includes less tangible aspects of the business, such as the ability to plan, strategize, execute and monitor results. Whether it is a young producer, entrepreneurial startup, an individual leasing most of the asset base or a business in transition, intellectual capital is crucial in building soft collateral.
Intellectual capital is increasingly becoming a significant factor as more land and equipment assets are leased. Current trends demonstrate a focus on controlling assets rather than owning assets.
How can one build intellectual capital, or soft asset collateral, when farm real estate equity does not exist? The first element would be to build a strong business plan using clear, written ideas. The plan should detail the short- and long-term goals for the business, family and personal life. This process appears to be basic, but it requires thinking through priorities and allocating capital, time and talent resources to their highest and best use. Monitoring progress can be used to ascertain whether equity is being built. This trend analysis can be useful in building a case to lenders and investors for additional borrowing or capital if the business is in growth mode.
Projected cash flow, production plans and operating schedules linked to a marketing plan are critical. Knowledge of payment schedules, timing of costs and operating capital needs are the intellectual horsepower that can be invaluable in soft collateral assets. To top it off, a cash flow analysis and sensitivity testing of various levels of production, marketing, prices and cost can provide the boundaries of possibilities.
Regularly monitoring results is an important part of intellectual capital. The difference between planned and actual outcomes can be determined using variance analysis. This process allows producers to adjust the business plan with changing conditions not only in the business, but also at the macro level.
For example, a young farmer started his enterprise with a used pickup truck, lots of energy, ambition and a well-though-out business plan on rented ground. Within five years, he had paid for his equipment and livestock loans with earned profits. These assets, along with a proven track record, were used as equity to acquire land assets with borrowed funds. In this particular case, the individual’s and spouse’s commitment to a modest lifestyle and dedication to working side-by-side with their agricultural lender were a win-win situation when land equity was non-existent.
Intellectual capital will make a significant difference in the agribusiness world, particularly considering shifts in consumer demand and market volatility. Sometimes it appears business owners who own a lot of land have a head start. However, this often leads to complacency and lack of focus on intellectual capital and management intensity. This is why it is often said that "the first generation makes it, the second generation holds the business and the third generation loses it." Why? The hard assets, such as land, can be transferred, but the critical element of intellectual capital is often not transferred to the next generation.
David Kohl received his M.S. and Ph.D. degrees in agricultural economics from Cornell University. For 25 years, Kohl was a professor of agricultural finance and small business management and entrepreneurship in the Department of Agriculture and Applied Economics at Virginia Tech in Blacksburg, Va. He was on special leave with the Royal Bank of Canada working on advanced initiatives for two years, and also assisted in the launch of the successful program at Cornell University. Kohl is professor emeritus in the AAEC Department at Virginia Tech.