From producers to haulage providers, Australian agribusiness has traditionally relied on conventional debt financing. Being captive to variable factors such as climate and cyclical business cycles, financial institutions often take a conservative approach to lending which has restricted the flow of funds. When adverse trading conditions limit revenue and compound debt levels, alternative sources of finance may be used to clear debt, remove unfavourable assets from the balance sheet and adjust cash flow forecasts.
Lease backs are attracting an increasing amount of interest in Australia, both from asset owners and agribusiness investors. Lease backs are ideally suited to entities looking to finance manufacturing plants, heavy equipment or rural land.
A lease back encompasses the sale of an asset, and a simultaneous lease agreement entered into between the vendor/lessee and purchaser/lessor for a period of time. This frees up capital in the asset while retaining the operations.
Lease backs are favourable for agribusinesses who have significant equity in an asset however have inadequate cash flow and escalating debt. The sale of the asset unlocks capital for debt reduction and reduces the cost of debt service. Lease backs are also advantageous for entities seeking to benefit from investment in the sector as the lease allows experienced operators to remain with the asset, providing management expertise to the investor.
A lease back involves a liquidity event, which may be unfavourable depending on the prevailing market conditions. However, an agreement can be drafted to allow the lessee/vendor to participate in any subsequent sale, whether as a first right of refusal to purchase the land or to participate in any gain in value of the land if there is a subsequent sale to a third party. Understandably, for this to occur there would be additional commercial costs to the lessee to facilitate this optionality.
Cow banks are utilised extensively by charities in developing countries, where a “bank” of cattle is retained to lend to people for use in breeding programs or to work fields. However, cow banks are gaining traction in commercial dairy operations, giving farmers the ability to increase herd size without the necessity to purchase stock outright. Cow banks suit producers seeking herd finance in order to expand operations.
Cow banks commence as either an agreement for new stock or to refinance an existing herd. In contrast to purchasing and financing cattle outright, a cow bank agreement allows the farmer to increase and decrease herd size to suit the needs of the business. Alternatively, a producer could utilise equity in their current stock by selling the cattle for their full value before leasing back. The ability to unlock full equity held in the cattle in this manner is advantageous over conventional cattle financing. A lender in the conventional scenario will only finance against the value of the cattle on a depreciating scale, leaving a margin of value which the producer must bridge. This is not the case in a cow bank agreement.
A cow bank may not suit a producer however who is focused on herd improvement and breeding programs. Further, it may not be a viable option for older cattle where a producer is looking to refinance the herd.
For the owner of the cow bank, the wellbeing of the cattle is taken out of their control and into the control of the producer. To mitigate the risk of adverse care, a cow bank agreement can provide for benchmark requirements on the producer, such as body condition scoring, pasture improvement targets and best practice animal handling requirements.
Forward sales streaming
Agribusinesses dealing in soft commodities, such as grain, livestock and fruit, generally receive revenue on delivery of the product. Agricultural commodities tend to have lengthy growth cycles, therefore the time between capital expenditure to produce the commodity and the time of delivery (and therefore receipt of funds) generally requires finance to bridge the operational gap.
Most commodity markets offer exchange or physical based forward contracts and therefore provide a known value of the revenue expected (dependant on yield). This known value provides an underlying security for advanced payments, prior to delivery. This is effectively a loan and will be either charged with interest, or the face value of the contract will be discounted to accommodate the finance costs.
The main benefit of financing against future contracts compared to traditional finance is that the funding is transaction based and is focused on the borrower’s performance, rather than the borrower’s balance sheet. The security for the finance is the underlying commodity. Streaming facilities further allow financiers to purchase additional volumes of the commodity, depending on the yield outcome.
Adversely, the unknown component of yield can place the seller in an exposed position if production falls short of expectation. Lower than anticipated production results in a shortfall of security against the cash advance. Financing against forward sales should be undertaken on a conservative basis and managed diligently.
A joint venture (JV) is a method to expand operations without necessarily taking on increased debt funding or investment. A new business, or special purpose vehicle (SPV) is developed with each JV entity sharing revenue and expenses.
Australian agribusinesses are increasingly adding value by vertically integrating, however such capital expenditure would require taking on higher debt levels or searching for outside direct investment.
By engaging another entity and forming a JV, businesses can vertically integrate up or down the supply chain, lending no more than their current capabilities to the SPV. For example, a business operating road haulage may want to add warehouse facilities to their supply chain. Equally, a warehouse business may wish to add transport to increase their service offering. The two businesses within a JV scenario could leverage each of their current assets and capabilities to provide an end to end warehouse and delivery service, maximising each of their assets.
Parties should be aware of any imbalances between the skill set and asset offering of each party when coming together to form the SPV. Objectives need to be clear and ownership of assets, including intellectual property, should be clearly defined. JVs are rarely long term business arrangements, more commonly established to target a particular business opportunity or goal. For this reason termination provisions are important clauses to draft in a JV agreement, encompassing the rights and responsibilities of each party on dissolution of the SPV.
Funding alternatives can add a degree of flexibility to agribusiness operations not found in conventional debt financing, relieving balance sheet pressure resulting from a “whole of farm” debt structure. It allows a blended borrowing approach to take advantage of different mechanisms for different types of operations.
Authors: Harry Kingsley & Terrie Morgan
Harry Kingsley, Partner
T: +61 3 9321 9888
Geoff Farnsworth, Partner
T: +61 2 8083 0416
Ron Eames, Partner
T: +61 7 3135 0629
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Published by Harry Kingsley