DETERMINING ABILITY TO PAY
Can your agribusiness afford to meet your family’s needs?
Once the financial needs of the senior generation, who currently own the business, are established, the obvious question becomes: can the business generate enough to pay for these?
Its ability to do so is determined by the answers to the following questions:
Can the agribusiness generate sufficient resources to finance these needs while still meeting its own capital requirements?
Will lenders, suppliers and other equity holders allow existing credit relationships to shift to the new ownership team without the personal guarantees from the senior generation?
Is the successor generation willing to suppress its own financial ambitions so that the needs of the older generation can be accommodated first?
Ability to pay is based on the future, not the past. This implies that it is crucial to ensure the long-term financial success of the business (as far as this is possible). This is often overlooked in traditional approaches to succession, which tend to focus exclusively on the company’s historical numbers and fail to consider what the agribusiness should look like in years to come.
Basing ability to pay entirely on the past violates the principle that the family agribusiness is the engine that will make a prosperous future possible. It also negates the idea that each generation of owners should regard themselves as stewards of the company.
BUILDING LASTING SUCCESS
Long-term business vitality centres on fostering ‘innovative development’, which involves attracting and holding
onto talented and motivated people, as well as having access to sufficient capital to sustain long-term growth. These fundamentals are all too frequently ignored by family businesses.
To be able to expand, remain competitive, and attract skilled and motivated people, an agribusiness should have the resources to afford the following:
Managers, employees and part-time labourers (if used);
Marketing and selling;
Capital for new equipment;
Start-up costs for new products;
Research and development.
Many owners of family agribusinesses fail to focus on these factors. Instead, they concentrate on a good work ethic, a commitment to customer service, and the ability to make intuitive quick decisions to thwart problems before they get out of control, or capitalise on new opportunities while others were still studying the problem.
In other words, they have put their focus elsewhere. Others rely on a product that they have produced and sold essentially unchanged for a couple of decades. With the tight margins common in today’s global markets and with product life cycles measured in months rather than years, many of these businesses are operating on borrowed time.
Such organisations must look to new consumer tastes, new distribution channels, and ways of increasing their
margins, or risk becoming unprofitable and falling by the wayside.
THE IMPORTANCE OF TRUST
One of the hallmarks of many successful family-owned agribusinesses is that they run ‘lean and mean’ and are proud of it. This is not necessarily a bad thing; even the public sector is trying to get back to the basics. But for many of these companies, this is more than a business strategy; it is part of their culture and deeply embedded in the owner’s need for control. The trouble is that these businesses have often grown in size and complexity, and it’s simply beyond the ability of one person to make all the decisions.
Taking the next step also has its hazards. If the new generation of owners elects to split up management functions, they may discover that serious distrust (usually unspoken) and disagreements can arise. The only solution here may be to subject managers to the discipline of professional governance by an impartial board of directors.
As described, to maintain technical competitiveness, adequately staff the organisation, and sustain growth, the business must be able to have access to sufficient capital. Implicit in this is the willingness of the senior generation to pass its equity on to the succeeding generation at little or no cost. In payment for this equity shift, the successor generation should be willing to restrain its own economic demands on the business during this transition.
Trust becomes a critical part of this equation, and this trust is best nurtured with the aid of a well-thought-out strategic plan that contains agreed-on targets for payments to the senior generation, and clearly understood benchmarks to ensure that the fiscal health of the business remains unimpaired. More often than not, owners and successors are surprised to learn that on this basis, the agribusiness does in fact have the ability to pay.
The real trouble occurs when this process is delayed too long; if this happens, there simply may not be enough time for the senior generation to harvest sufficient resources without crippling the company with debt or forcing it into questionable quick-fix strategies.
When the equation truly cannot be balanced, it is probably time to sell. Unpleasant though this reality might be, discovering it as part of a respectful, inclusive planning process is surely better than ignoring it until the successor generation becomes tired of waiting or the agribusiness is sold in a panic due to ill health.
THE NUTS AND BOLTS
The objective at the end of the day is to create additional, non-business net worth for the senior owners, and
ultimately eliminate their financial dependence on the company. If these owners are still on the company’s debt as personal guarantors, negotiations with the lenders will probably be necessary to eliminate or shift those guarantees to the younger generation before the senior owners can be expected to part with significant equity.
As the company initiates such a plan, actual equity must begin moving between the generations as the determined benchmarks are reached. This is important not only because it will enhance the level of trust between generations, but because it will send a strong signal to lenders, suppliers, key customers, and employees that the transition is moving forward on time and as planned.
There are a number of ways to provide the senior generation with additional resources:
Increase compensation so that it is geared to profits or sales for a specific transition period. This should lessen any concerns about its being unaffordable or unreasonable.
Increase the rentals of outside-owned properties or equipment used by the business, or buy additional property or equipment for this purpose.
Set aside consulting compensation for post-succession assistance to the company and/or lump-sum payments for non-competition covenants.
Repay old shareholder debt.
Create passive income streams with equipment partnerships, royalty income and directors’ fees.
Even if it ultimately proves impossible to balance the equation, doing the sums promotes an essential dialogue
among the three constituents of the transition: the senior generation, the successor generation, and the business and its stakeholders.
This fosters an understanding of the business fundamentals that are involved in a succession, and, in some cases, helps to prevent conflict. If the equation does balance, the results will be more predictable, people will feel included and valued, and the business will have taken a giant step towards becoming a long-term wealth generator for all owners, past, present and future.
Published in the January 2022 Edition of Farmer's Weekly
Family Legacies www.family-legacies.com is a multidisciplinary family business consulting company. Our consultants are leaders in their respective fields including; Family Business Consulting, Strategic Planning, Financial Planning, Wealth & Risk Management, Corporate Finance, Business Transitions & Exit Planning - Buy, Improve, Grow & Sell Businesses, Commercial & Family Law, Executive Coaching, Leadership Development & Facilitation, providing our clients with a professional and integrated multi-disciplinary service.