Editor’s note: This is the third article in a series. Read the other two article: COVID-19: A hard conversation about the risk and Cash flowing to the other side of COVID-19.
Guardians of the Galaxy was a fun superhero movie in which a group of unlikely characters were thrust into the impossible task of guarding the galaxy against certain doom. While Drax the Destroyer, Groot and Rocket Raccoon are not dairy farmers, dairy farmers too have faced their own supervillains in the form of an extended period of low prices and now COVID-19. Like their big-screen counterparts, dairy farmers are guardians as well, potentially having to make tough – but right – decisions to guard their equity for their families and themselves.
Equity is the wealth you have earned in your business and what is used to cover negative profits. Continuing negative profits drains your equity. If the prospect for future profits is not high or not high for a while, then the question becomes: How much equity are you willing to spend? Without a doubt, the decision to guard equity by transitioning to something new is one of the more difficult decisions an owner/manager will ever make. Doing so starts with a thoughtful and frank analysis of the operation’s current status, including financial, infrastructure and management.
Financial analysis
What is the trend of profitability, equity, working capital, costs of production, debt and family living expenses? How do these financial metrics compare to industry standards and/or peer groups (Table 1)?
How will these metrics look in the future if prices are greater than $18 per hundredweight (cwt), $15 to $18 per cwt or less than $15 per cwt for a prolonged period? Even before a deep dive into the numbers, there are questions whose answers can hint at financial challenges, including:
- Is debt for the purpose of covering previous losses or past-due accounts payable increasing?
- Have you restructured debt but still have challenges making payments?
- Are you worried about limited cash reserves in the event of a major breakdown?
- Are credit card and charge account balances increasing?
- Is asset maintenance and replacement being deferred?
- Are production practices being sacrificed to save costs and pay bills that are due?
- Is the amount of equity (wealth) in land, buildings, cattle and machinery decreasing?
It is not unusual to answer “yes” to some or all these questions periodically. However, the more “yes” answers, the more the answers stay “yes” over time and the more answers staying “yes” even when we see a return to average prices, the more that is a signal to consider next steps for the future of the operation.
Infrastructure analysis
What is the status of your buildings, milking system, machinery and other technology? Buildings, technology and machinery must be maintained and eventually modernized or replaced before becoming unusable, obsolete or less efficient. The older the infrastructure and technology, the higher the likelihood of increased costs of production. This can be a slippery slope that eventually eats away at profit margins and equity. It may be a slow bleed but a bleed nevertheless. Questions to consider include:
- Is the operation able to keep up with maintenance and replacement of capital assets, or is the operation falling behind and creating a time when a major cash infusion will be needed?
- Even under the best of maintenance and updating, operations eventually face a need to modernize. Is that time now for your operation, and how much investment will it take?
Major capital improvements are costly, with expenses coming first and benefits later. Depending on the new investment, it may also require a new set of management skills. If you find yourself in this situation, consider whether you are up to the challenge and willing to make the long-term commitment that will be required.
Consider how your age may impact this decision. Do your plans allow you to reap the long-term benefits, or are you in a place where you would spend your equity but not be involved long enough to collect the benefits?
You might justify major infrastructure investment as a means to set a foundation for the next generation. However, bringing in a successor while the business is in the front end of the infrastructure investment may strain the capacity to manage, service new debt, provide for another family’s living and provide retirement income for the current owners.
Management analysis
The last area to assess is a self-reflection of your management. Are you prepared to continue the challenges of your current situation, or would you be more effective, satisfied and successful with transition to something different?
Age plays a role. Younger managers are guarding their opportunity to be in and grow their operation. They may be willing to take more risk and invest because they have longer to reap the benefits – and frankly, they may have less to lose in terms of their own equity. Older managers may be just the opposite. They may not have as much time to see the benefits and may have significant equity at stake. It may be better to make change now and keep your equity.
The manager’s capacity or talent to manage is also a consideration. Does the manager have the tools, know-how and willingness to change as needed to meet future challenges of production, marketing, finance, human resources, technology, risk management, public relations, environment, etc.?
Finally, and perhaps most important, does the manager have the energy, enthusiasm and passion for the industry? If motivation is low, it is hard to continuously make good decisions for the long-term health of an operation. It is better to be transparent today than “force” yourself into a future situation that will result in losing your hard-earned equity.
Tomorrow morning after breakfast
I have decided the best decision for my family and myself is to guard my equity and consider transitioning to something else – now what? First, congratulations on making the tough decision to guard your equity. Three potential first steps for guardian transitioners are:
1. Develop your team including spouse, business partners, parents, siblings, lender, suppliers, consultants, accountant, attorney and your kids. The value of a team is that more brains are involved in developing ideas and identifying the pros and cons of each. Involving others, especially family members, also gives them the opportunity to grow their understanding of the need for change and support the ultimate decision.
2. Organize discussions, perhaps facilitated, to generate transition options from exiting to alternatives for new business models. Examples include:
- Partial liquidation that reduces debt burden, provides working capital and yet preserves a family legacy and/or potential seed for the next generation to use as a foundation to build a new operation of their own.
- Partnerships or cooperation with other operations who may be in similar circumstances. This could provide the ability for both operations to sell assets, pay off debt and gain greater efficiencies. For example, sending the cows to one farm that has better facilities while the other farm with better machinery and land management know-how takes over cropping activities.
- Preserve your land base, maybe even cattle and buildings, by leasing them to another operation and selling your associated machinery and equipment. Rental income can complement other income sources, and the land (maybe cattle and buildings) remains in your name as a foundation for future possibilities.
- Complete exit done in an orderly way that manages taxes, gains the greatest value for the assets and preserves the most equity.
3. Consult with your lender, accountant and attorney on taxes and other implications and develop plans that result in the best preservation of your equity. For example, an orderly dispersion of assets over multiple years both to manage taxes and provide time for good sales opportunities may be more optimal.
Amid the 1980’s farm crisis, a family member was faced with the difficult and painful decision to guard his equity. He made the tough decision but did so in a way that allowed him to keep some land. Now, with 25 years in the rearview mirror, his son has been able to use that land as a foundation for his own operation. That family member now gets the thrill of watching the equity seed he guarded 25 years ago flourish today.
A colleague suggested a most appropriate final quote from President Theodore Roosevelt: “In any moment of decision, the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing you can do is nothing.”
