28 December 2001

USECONTRACTFARMDEALSMORE OFTEN

Contract farming agreements may not quite be the cure-all

that farming is seeking, but they are as good as you are

likely to get, says one independent consultant

CONTRACT farming agreements have stood the test of time and can provide a higher, more secure income than traditional farming, says Peter Day, who runs Peter Day Property Services from his base at Swannington, Norfolk.

More farmers should make use of them, he believes. "Such agreements also have the benefit of reduced worry and daily commitment but with the satisfaction of a continuing farming business. They can and do restore the enjoyment of farming and very substantially enhance the quality of life of those farmers currently under the very greatest of pressure."

Faced with the lowest incomes for two generations, and little prospect of improvement in the short term, they provide a tested route for getting a farm business back on track, says Mr Day.

"The great majority of farmers have already reduced their variable inputs to the lowest level possible. But to reduce fixed costs further is much more difficult. To farm in the 21st century you must have up-to-date machinery and a skilled labour force, as the dangers of skimping on these have been only too clearly exposed by the appalling autumn weather of 1999 and 2000."

To an outsider, selling the farm may be the most obvious solution. But most farmers are very reluctant to do so, for several reasons, he says.

"Few farms have been offered for sale over the past two to three years. Firstly, the farm is most farmers home as well as their business and there will always be a great reluctance to relocate to pastures new.

"Secondly, if the farm is sold – and there is no guarantee in this market – most farmers would be very fearful of where to invest the proceeds with security to achieve an adequate retirement income in the volatile markets that have and will continue to prevail.

"Lastly, if the farm has a value of more than £242,000, then on death any excess will be taxed at 40%. The whole of the value of the farm if occupied and farmed will be free of inheritance tax." Given that an overwhelming number of farmers want to stay put, what are the options?

Some may consider a farm business tenancy. While this can provide a secure and regular income, it removes all the farmers involvement in the business and any control of it, says Mr Day. "It doesnt suit everyone."

A co-operation agreement with one or more nearby farmers is another route, but Mr Day believes it is probably more suited to younger farmers.

"Its success is hugely dependent upon finding the right partners to join up with. Size of unit, skill and age of partners and financial resources for re-equipping are essential to success and the wrong selection can, and has, brought great unhappiness, most usually to the smaller partner in the group."

For these reasons, he believes that contract farming is the most effective and attractive option. "It retains control of the business and occupation of the family home. It also removes the day-to-day management responsibility, and the day-to-day responsibility for physical work. Farmers retain a financial interest in the business.

"In essence, it involves replacing the farmers principal fixed costs of labour and machinery at a much reduced rate by using the contracting farmers existing machinery and labour to optimum efficiency."

Great potential

Potential benefits are great, says Mr Day. A farmer running a 500-acre cereal and sugar beet unit could typically expect to raise profits by almost half (see table).

"In addition the farmer may sell his machinery for, say, £75,000. This could provide additional income, at 4% interest, of £3000/year. And in many cases it may be possible for the owner to do some paid work or alternatively to develop another business, enhancing his overall income."

Although it sounds easy, and in practice can be easy, it is absolutely vital to choose the right contractor at the outset (see panel).

Nevertheless, some people criticise these agreements because the contractor receives a share of the profit, says Mr Day. "But they should remember that profit is created jointly by the parties through cost reduction, not through income enhancement. This is why all agreements should provide for unanticipated profits, in excess of budget, to be divided equally, as invariably such largesse arises through good fortune rather than good management."

Agreement period

Agreements should normally be for three years, although Mr Day knows of some that have lasted over 20 years through regular renewal with terms varied to reflect the changing circumstances prevailing over the years.

The parties should decide at the outset whether they need regular professional support in the administration of the agreement, he says.

"But at the very least they should employ professional help to set up and document the agreement, and agree to rely upon that person to resolve disputes in the unlikely event they arise in the future," he concludes. &#42

A Existing direct farming

Costs

Labour (including farmers

unpaid) 30,000 60/acre

Machinery 50,000 100/acre

Administration 15,000 30/acre

Total costs 95,000 190/acre

Gross margin 131,000 262/acre

Profit before tax

and interest 36,000 72/acre

B Contract farming agreement

Gross margin

(as existing) 131,000 262/acre

Contractors

costs 40,000 80/acre

Administration 12,500 25/acre

Total costs 52,500 105/acre

Profit 78,500 157/acre

Farmers

first share 35,000 70/acre

Residual profit 43,500

Owners

share (40%) 17,400 35/acre

Contractors

share (60%) 26,100 52/acre

Increase in

owners income 16,400

NB The agreement should provide that residual profit of more than £43,500 should be divided 50% farmer and 50% contractor

&#8226 Someone whom the farmer likes and respects.

&#8226 Local (within 5-10 miles) with speedy access to the contracted farm.

&#8226 Skilled, committed and financially sound.

&#8226 Experienced in crops best suited to the farm. Preferably farms complimentary soil types which relieve time pressure at critical periods.

&#8226 Agrees terms that are fair to both parties and based on a realistic budget.

Well worked out contract farming agreements can be a boon to farmers currently suffering great pressure.

Make sure you choose the right contractor from the start, says Peter Day.