Equity partnership

• Can create a business with expertise in different areas.
• Enables parties to invest in the agricultural sector without having to be involved in the management of the property
• A method of succession planning
• A method of releasing equity within the business for retirement planning.

• Undertaking due diligence on the business/farm and the potential equity partners is critical to success.
• Being in business with other parties introduces the risk of the financial security of the other investment parties.
• Equity partnerships are still exposed to the risks of running a business in the dairy sector, e.g. the milk price, climatic events, regulatory risk etc.
• There can be some significant challenges in cases where the equity manager/sharemilker only has a small percentage of equity (<20%) in the business. The equity manager/sharemilker should be aware of the cash returns on their investment and how easy it is to remove equity.

• Equity partnerships should generally focus on agreed profit and cashflow objectives, rather than relying on the potential for capital gain.
• Undertake due diligence on both the potential business/farm and the potential partners.
• Having the right people with similar farming philosophies and values
• Good communication and governence throughout the duration of the agreement
• Clear understanding of the business goals, management plan and measures of success for the business
• Universal agreement around the payment of dividends. Is the expectation that dividends are paid out each year or reinvested for development? Additionally, are shareholders required to invest further capital if there is a deficit?
• If one equity partner is to run the day-to-day aspects of the business as a manager/contract milker or sharemilker, a separate employment/sharemilker agreement is required with a very clear process of reporting and performance review process to address any performance issues.

The returns from an equity partnership would reflect any standard owner-operator model divided between shareholders (e.g. 20% of profit plus 20% of capital growth).

Typically, the key driver of the business is profitability leading to greater return on investment. Return on investment can vary significantly depending on the farm management ability, timing of entry and exit, quality and value of the land asset purchased.

The average return on total assets over the 10-year period from 2005-2015 was 7.1%. However, returns vary significantly from year-to-year as shown in the graph below.

Equity partnerships can be difficult to exit if the process is not clearly defined.

They should be set up with a clear timeframe, e.g. 3 years/5 years/10 years etc.  At the end of the agreement the parties can decide whether to extend the agreement or exit and how this should happen.

A policy for valuation of the business at the start and end of the agreement should be included.

Sharemilker

• Individuals are not required to have 100% of the equity for the sharemilking business
• If in partnership with the farm owner at the end of the term there is a guaranteed buyer for cows.
• Benefit of high cash returns of a sharemilking business

Other equity partner/s

• Have someone running the day-to-day aspects of the business with ‘skin in the game’ and similar drivers for profitability and efficiency due to sharing of the costs and profits
• Has more influence over the cows on the property ensuring continuity of cow genetics
• Land assets are kept separate

Sharemilker

• Potential liaising/reporting to their equity partner as well as the farm owner.
• The incoming sharemilker is vulnerable to the change in value of the cows as they are buying into the business and selling out again at the end of the agreement.

Other equity partner/s

• In a situation where the farm owner is required to re-purchase the shares of the managing sharemilker at the termination of the sharemilking agreement, the farm owner is open to the change in value of the herd.
• Although the managing sharemilker has a vested interest in herd performance and profitability, if the herd stays with the farm owner at the end of the agreement there may not be the same feeling of ownership in some aspects of management such as reproductive performance.

• Clear areas of decision-making between parties e.g. clarity around who makes decisions within the sharemilking business such as breeding and culling decisions.
• Having the right people with similar farming philosophies and values.
• Clear understanding of the business plan.
• Good communication throughout the duration of the agreement.
• A clear policy around the valuation of the business at the start and end of the agreement.
• Clear timeframe for the partnership with clarity around exit strategy and what happens if the partnership needs to be terminated prior to the end of the timeframe.

The key drivers for the herd owning sharemilking business is profitability.

The equity required varies dependent on the size of the sharemilking business and cow values which can vary significantly from year to year.

Average returns of a herd owning sharemilking business are around 15% return on asset, although the range can be significant due to the large fluctuations in cow values.

For a more detailed financial example see the factsheet.

Entry and exit is relatively easy compared to other equity partnership agreements that involve the land.

• Encourages a progressing farmer to become part of the business.
• Helps to align the drivers of success for both the person(s) managing the farm and the farm owner.
• Frees up equity for the existing farm owner.
• Given land prices fluctuate less rapidly than cow prices, there may be less asset value risk compared to investing in a HOSM venture.
• Banks will lend a higher ratio against land in comparison to livestock. This enables more financial leveraging to occur.

• Requires a good working relationship between both parties, as do all agreements.
• Lack of management control for a progressing farmer, compared to farm leases or other options.
• Cash returns are relatively low compared to HOSM and other models.
• Exit from the arrangement can be more difficult.

• Clear agreement on how farm management decisions will be made, who has final say on farm management decisions and the exit process.
• Choosing the right equity partner can significantly grow your business, just as the wrong equity partner may ultimately hold you back.
• Equity partnerships should generally focus on agreed profit and cashflow objectives, rather than relying on the potential for capital gain.
• Undertake due diligence on both the potential business/farm and the potential partners.
• Good communication and governance throughout the duration of the agreement
• Clear understanding of the business goals, management plan and measures of success for the business.

The returns from an equity partnership would reflect any standard owner operator model divided between shareholders (e.g. 20% of profit plus 20% of capital growth) if assets included land, herd, machinery, plant, buildings, and shares.

If the equity partnership is for land only, then the returns may be similar to lease agreements with shareholders receiving a share of the lease rental.

Return on investment can vary significantly depending on the farm management ability, timing of entry and exit, quality and value of the land asset purchased.

Clear business timeframe with the entry and exit process specifically outlined: this should include the exit process if one party needs to exit before the end of the timeframe.

A clear policy around the valuation of the business at the start and end of the agreement.

Progressing farmer

• From a farmer progressing perspective the investment in Trade Co is reasonably liquid and allows them to benefit from increasing farm profitability.
• This model creates a shared goal of farm profitability, which helps aligns financial motives between all parties. Having the progressing farmer better understand the business and its expenses can assist with better farm management and skill development.
• The investment required to invest in a Trade Co is significantly less than if land is included, which makes entry and exit easier.

Farm owner

• From the farm owner's perspective having another party provide equity may improve their balance sheet.
• May suit farm owners looking to exit from the day-to-day running of the property or looking for a succession model.

• As with all equity arrangements it is important that the core farming philosophies of all parties are understood and are aligned.
• If the progressing farmer leaves the Trade Co partnership they must realise any capital gains or losses in stock values at that point in time, and as such are susceptible to fluctuations in livestock values.
• Setting a fair lease rate, with transparent methodology is critical. There should also be a market based relationship between both Trade Co and Land Co to satisfy all parties.

• Equity partnerships should generally focus on agreed profit and cashflow objectives, rather than relying on the potential for capital gain.
• Undertake due diligence on both the potential business/farm and the potential partners.
• Good communication and governence throughout the duration of the agreement
• Universal agreement around the payment of dividends. Is the expectation that dividends are paid out each year or reinvested for development? Additionally, are shareholders required to invest further capital if there is a deficit?
• If one equity partner is to run the day-to-day aspects of the business as a manager/contract milker or sharemilker, a separate employment/sharemilker agreement is required with a very clear process of reporting and performance review process to address any performance issues.

Trade Co.

The returns to Trade Co will be influenced strongly by the agreed rental.  In areas with high land values, calculating the lease rate using productive potential may be more appropriate to ensure Trade Co remains a viable business.

Trade Co can be expected to offer returns similar to, although slightly lower than, a HOSM business in an average milk price year (10% - 15%). This is due to the proportionally large investment in lower yielding dairy company shares (if required) compared to that of a traditional HOSM where the farm owner would retain the dairy company shares.

Land Co.

The financial returns for the Land Co. are driven by the lease rate and any capital gain.

Financial returns are dependent on the lease rate negotiated. A simple return such as 4% of land value can be used to set the lease
i.e. 4% of $45,000/ha = $1,800/ha

Alternatively, the lease is decided from the productive potential of the land
i.e. 1100 kgMS produced x $5.50/kgMS milk price x 23% share of milk income = $1,392/ha (3.1% return)

For a more detailed example of equity and returns for this type of Equity Partnership see the factsheet.

The ability to invest in Trade Co will involve more modest sums, and the entry and exit into this arrangement with a clear contract agreement should be no more difficult than a conventional HOSM agreement.

Any investment in Land Co is likely a more significant investment and will be less liquid.  It is possible that this arrangement could be conducted outside an investment in Trade Co and a progressing farmer may be able to leave an investment in Land Co ongoing or until such time as another suitable investor is found.