How to protect your farm business from risk

How clearly do you know the direction of travel of your business? Have you asked yourself where you would like to be in five, 10 or even 20 years’ time? How prepared are you to deal with volatile commodity markets or unforeseen circumstances arising from family issues?

According to Edward Dixon, partner with Knight Frank, most farming businesses don’t have such an up-to-date plan.

As the world becomes more unpredictable, however, developing one and making sure major decisions are sense-checked against key objectives is becoming more important.

“Farmers have to make sure they are ready for both the expected and the unexpected,” he says.

See also: Advice on surviving the arable cashflow crisis

“While it may be tempting to say that there is no point in trying to mitigate risk when you can’t control things like the weather and global commodity prices, there is plenty farmers can do to improve their exposure to risk.”

Stress testing

One way of doing this is through a process called stress testing.

This involves auditing a business to work out where the weak points might be.

It means identifying all the factors that could have an impact on the business and modelling these risks so the potential impact can be assessed – and then putting in place measures to mitigate them.

“It allows you to be proactive. Sometimes by looking further ahead, you can make better short-term decisions, which may see you through some difficult times and put you in a better place,” says Mr Dixon.

“Banks will also really appreciate it if you have gone through this process as it gives them a clearer vision and understanding of where the business is going.”

Knight Frank’s stress testing tool is more typically used to help large estate owners plan, but Farmers Weekly asked what a 500-acre family-run arable business should consider if it wanted to take a similar approach.

Clarify your objectives

The first step of the process is to really think through what the objectives are for the business and on what timescale.

This critical process must involve all generations, as the aspirations of the younger generation might be quite different to that of parents or grandparents.

“It requires an honest conversation and it can be helpful to have someone independent involved to facilitate the discussion,” says Mr Dixon.

“Some businesses might be focused on expansion or the quality of their produce because they want to develop an added-value enterprise.

“Others might say the objective is to maximise the revenues of the farm or enhance the asset value of the business.”

Figuring out what the objectives are helps the create a roadmap against which business decisions can be taken.

For example, if the farm gets an approach about installing solar PV then that decision can be taken in the context of where the business is going as a whole, rather than in isolation.

Have frank family discussions

Each member of the family’s plans should come out of the discussions about objectives, but having an honest conversation about expectations can throw up unexpected issues.

For example, Knight Frank worked with one estate where it emerged all the planning had been on the basis that the estate would be split equally between three siblings.

However, after discussion it was realised that the best course of action was for the youngest child to take over the estate, which meant the succession planning process had to start again.

“You need to know if one partner is saying they want to retire in 15 years’ time, so you can start working towards it. There’s even a value of knowing what young partners coming into a business think about their retirement, as it will have a bearing on the way they run it.”

Carry out a skills audit

Identifying the different skills that each individual brings to the business helps to identify where it might be able to go in the future, says Mr Dixon.

Some people may have skills or interests which bring new diversification opportunities, if harnessed in the right way.

“I’ve seen someone with a real passion for shooting set up a really successful commercial shoot, alongside the farming enterprise. People tend to make something successful if they are interested in it.”

Carrying out a skills audit also helps identify where there are gaps and if training would be helpful.

If there are children coming back to the business after university it can be helpful if they work elsewhere for a while first, he adds.

“It really pays to get experience from outside and working in other industries can be valuable.  It is also good to be manged by someone else because it develops people management and communications skills.”

Consider a joint venture or CFA

If a traditional estate derives more than 50% of its income from farming then it would normally be advised to seek to bring that down so it is less exposed to the swings in agricultural markets, says Mr Dixon.

The equation is different for a 500-acre farm, where an 80-100% reliance on agricultural income might be more usual. But it might be more relevant to look at the balance between the different enterprises to understand how dependent you are on each sector.

As part of this process, people should question how best their time can be used and be open to all ideas. This includes considering whether a joint venture or contract farming agreement (CFA) would be beneficial, he says.

See also: More business advice in Business Clinic

Some people will find it difficult to consider a CFA as they question what would they do instead. “But in a lot of cases, people would be as well off or better off doing it.”

CFAs can also be used to help diversify.  

“A client running a successful arable business decided he wanted to set up a new poultry enterprise,” says Mr Dixon.

“At first it looked like the options were either to take someone else on or run himself ragged working across everything. But we agreed the best resolution was to bring someone else in to contract farm the arable side.

“It goes back to being clear about objectives . He decided that he wanted to increase his turnover, spread his risk by diversifying his income and not compromise his family life – and that’s what we’ve done.”

Renting vs contract farming

Over the past two decades, many farming businesses have expanded by taking on extra land at high rents with the expectation that it will pay because they are spreading their fixed costs.

But Mr Dixon says with commodity prices under pressure, tough questions need to be asked about whether the land really is paying for itself and whether a strategy of reducing fixed costs, perhaps by using more contractors, is a better option.

It is also worth starting a conversation with your landlord about whether there is an alternative approach to renting.

A private landlord may be willing to consider a contract farming arrangement, rather than a letting one, given it offers them trading income for tax purposes. This means your business is sharing the risk, rather than bearing it all.

Identify diversification opportunities

Identifying sensible diversification opportunities is the obvious route to improving returns and reducing reliance on core agricultural activities.

Farm businesses often come with property that will have a value for either leisure, commercial or residential purposes. Renewables is another option.

But farmers need to be really clear about the risks associated with a new enterprise and the new regulations they will face, says Mr Dixon.

The challenge in any diversification is ensuring that you have the skills and the passion for it, as that it what will see you through when things get challenging. You also have to look at borrowings and affordability.

“Banks will look at the cashflow of existing businesses so it can support any diversification in the start-up period.”

Make informed cropping decisions 

A lot of growers make their cropping decisions without really thinking about where the market is going to end up, warns Mr Dixon.

“A lot of people go with what they feel comfortable growing, but are they really talking to the traders and asking what varieties is the market looking for because that is continually changing?”

Depending on what part of the world you are in, buyers may be looking for certain grain in terms of grouping, so they can blend and bulk up their product. There may also be contracts available which enable you to secure a margin.

Be savvy with borrowings

A potential warning sign within a business is when it has been burdened with debt which was taken on without enhancing the business, says Mr Dixon.

If you are looking at diversifying and need to borrow money to do so, then you need to be looking at servicing that debt from existing enterprises during the start up-phase.

You also need a back-up plan for how you would pay off that debt, if you need to sooner than anticipated, to minimise the impact on the core business.

Sometimes people go to the people they know when looking to borrow money and a supportive bank is worth working with. However, there is no harm in spreading the net a bit wider, says Mr Dixon.

“I recently worked with a client who borrowed money to buy land through the Royal Bank of Canada.”

Prepare for future regulation

While farmers have no control over issues like the future direction of the CAP or moves in land prices, changes in them are still worth building into any calculations for five or 10 years ahead, says Mr Dixon.

“Be prepared for a reduction in CAP support and if there is not a reduction support will be paid for delivering different things.”

Anticipating future regulation is another aspect of stress testing the business. For example, at the moment farmers are being incentivised to improve environmental performance.

“But if we start regulating, that could put a lot more cost into businesses.”