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Introduction | Business arrangements | Conclusion | References
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Introduction
As Alberta’s agriculture industry matures, business arrangements and business relationships continue to become more important. Working together can lead to better profitability and financial survivability. This paper takes a look at the basics, and also some reasons why an innovative business arrangement may be in your future.
Business arrangements are agreements between two or more people describing how they will work together. Types of agreements include contracts, crop share agreements, joint ventures, partnerships, corporations, co-ops, value chains and alliances. Each type of agreement has its own characteristics, advantages and disadvantages.
Working with others in some type of business arrangement has its pros and cons. Advantages include better economies of scale and size, more efficient use of labour and management, easier access to financing and better access to markets. Factors on the negative side may include: loss of independence or control, increased time spent on business relationships, succession issues and risk relationship breakdown.
To become more efficient, businesses usually have to grow. There are four ways this can be accomplished: expansion through profits, debt financing, equity financing and business arrangements. This paper concentrates on growth enabled through working together.
Business Arrangements
The earliest and simplest business arrangement, the sole proprietorship, is not a business arrangement at all, but rather an extension of the individual person into business affairs. In a sole proprietorship, the individual and the business are inseparable for legal and taxation purposes.
Joint ventures
When two or more sole proprietors (or other legal entities) work together to try to make a profit, the result is a business arrangement. The simplest and least formal is the joint venture. A joint venture is formed when two or more individuals pool the use of their business assets. However, the ownership of these assets remains in individual hands. Joint ventures began in the oil patch where they are recognized as legal entities. In agriculture joint ventures are essentially invisible for tax and legal purposes. Assets are owned and taxes are paid by the entities that make up the joint venture. In addition, joint ventures are generally intended to cover a specific project or length of time. These characteristics make the joint venture one of the most flexible and useful business formats available to Alberta farmers.
Partnerships
Since partnerships are recognized legal arrangements, they tend to be more formal than joint ventures. Partnerships can own land and other assets and have income tax implications (income tax may be assessed to the partnership but is paid by the individuals making up the partnership). When assets are transferred into a partnership, they become property of the partnership and the individual receives a “partnership interest” in return. Partnerships are especially useful in succession planning but can be problematic if not maintained properly. They can be very difficult to wind down in the case of major disagreements among the partners.
Corporations
The corporation, or limited company, is the choice of many large or expanding farm operations. A corporation is a legal entity that can do almost anything that a person can: own property, earn income, pay taxes and so on. Corporations clearly separate the functions of ownership and management, and they also provide a level of limited liability to their shareholders. Corporations pay a reduced level of income tax on the first $250,000 of income. However, corporations have no protection from capital gains such as the $500,000 Capital Gains Exemption or the Family Farm Rollover Provision. For those reasons, many farmers choose to own land as individuals.
New generation co-ops
There is currently new interest in co-ops due to the revision of provincial co-op legislation to include new generation co-ops, or NGC’s. NGC’s are special co-ops that are suited to processing or other value-added operations. NGC’s allow the issue of designated shares that can carry delivery rights and obligations. Under this format, investors can purchase the right to deliver a specified volume of commodity (grain, livestock, etc.) and to receive a patronage payment based on the success of the operation. New generation co-ops may have advantages when large community-based initiatives are being considered. For smaller projects, a corporation is another good alternative. NGC’s gained a reputation during the 1980’s and 1990’s in the northern United States.
Value chains and alliances
Value chains and alliances tend to be broader-based accords that depend more on business relationships than on formal written agreements. Alberta Agriculture, Food & Rural Development’s Value Chain Initiative defines a value chain as a vertical alliance of enterprises collaborating to achieve a more rewarding position in the marketplace. As agriculture becomes more oriented toward consumers in the global market place, these types of relationships may help ensure continuing access to markets.
Why work together?
What are the benefits of working together with others in a business arrangement? Part of the answer to this question is "basic economics." For a business to become more profitable and financially sustainable, over the long term it must either increase its revenues or decrease its costs. Several individuals working together may be able to increase revenues by:
- Pooling, sorting, selecting and packaging their products so they are more attractive to the buyer (eg. liner loads of cattle, B-trains of grain, product available all year long, etc.)
- Gaining or maintaining better access to markets. Individuals working together may be better at attracting and holding contracts from key market players.
On the cost side, labour, capital assets and management are often under-utilized on smaller operations. By combining their efforts, individuals may be able to significantly reduce these costs. For example, most 4-wheel drive loader tractors that currently feed 100 cows could be feeding 200 and more. If two operators, each with 100 cows fed their herds together, tractor depreciation costs per cow would be halved. Variable costs may also be reduced, both because larger operations can purchase inputs at a discount and because they can afford the newer, more efficient technology.
The perspective of the balance sheet
One way to look at the effectiveness of business arrangements is to think about a farm business as a balance sheet. Assets are balanced by claims against those assets by two types of people: lenders and owners. Lenders’ claims are represented by the Liabilities section, and these claims must be paid first. Owners’ claims are shown in the Equity portion of the balance sheet, but these claims are second in line to those of the lenders.
In order to "grow" a business so it can take advantage of the strategies discussed above, one or more of the following strategies can be considered: Grow from profits, debt financing, equity financing or, working together in a business arrangement.
1) Grow From Profits
2) Debt Financing
3) Equity Financing
4) Working Together in a Business Arrangement
Problems
Like everything else, working together has its challenges. Historically, farmers have avoided business arrangements and employer / employee issues by investing in technology: bigger tractors and combines for example. Farmers are well known for their independence, so feelings of loss of control can be significant. Building and maintaining business relationships takes time and effort and that adds to the costs. Another potential issue is the risk of relationship failure. If you own the tractor and I own the drill, we’d better make sure our business arrangement is sound when the calendar turns to April.
Conclusion
Working together, building relationships and forming business alliances are part of our industry’s evolution to one that is sustainable, highly diversified, responsive and consumer-focused. Business arrangements represent some of the basic building blocks that can help us move toward those goals.
References
Tax Management Strategies for Farmers, Alberta Agriculture, Food & Rural Development, Agdex No. 400\837-1, 1997.
Ted Darling, PAg
Alberta Agriculture, Food & Rural Development
Airdrie, Alberta
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