EXPANDING?YOU COULDCONTRACT
EXPANDING?YOU COULDCONTRACT
Contract farming could be one way to expand your business – or to get out while
retaining a farming interest. Chester-based Strutt and Parker dairy business consultant
Keith Thomas looks at the pros and cons from both sides of the fence
IN arable regions there is barely a parish now where some land is not being cropped under a contract farming agreement, the system by which land in different ownerships is pooled for greater efficiency and better returns.
Such arrangements have seldom been taken up within the dairy industry, but as returns from leasing quota fall, linking up with another producer should be seriously considered.
Take, for example, Mr John. He is 56 and after 40 years of milking he is ready to stop, particularly as neither his son nor his daughters are the least bit interested in coming into the business. He has a 120-cow herd on his 70ha (172 acres) and a well-found milking unit and buildings, all capable of handling another 70 milkers. Just a couple of years ago he could have realised capital from the sale of his stock and equipment and generated a steady income from the lease of his quota, but not now.
Mr James is 35. Over the past 10 years he has built up to a 70-cow herd and a 40ha (100 acre) rented holding. Hes done well, but hes ambitious and wants his business to grow bigger, as indeed it must if it is to survive in these competitive times. Growth, though, means borrowing and finding more land. The former, even with low interest rates, is more than the business can bear, the latter is simply not available.
Now is the time for both men to get together and set up a contract farming agreement (CFA).
For his part, Mr John, as the farmer, will provide the land and buildings, fixed equipment such as the milking parlour, quota and possibly the breeding livestock – the farmer inputs.
Contractor input
Mr James, the contractor, will provide labour, machinery, management and breeding livestock – the contractor inputs. He will also bring to the partnership youth and enthusiasm and his management expertise. Mr John will appreciate those qualities and how they can benefit him rather than feeling threatened by them.
Mr James will be paid a basic contract charge plus an additional performance related contract charge according to the profit. Mr John will retain the balance.
If they are sensible, both men will start talking now so that all between them can be settled and drawn up within a sound, comprehensive and legally binding document to enable the arrangement to begin in April, the start of the next financial year.
This date is appropriate for fiscal reasons and because valuation of items such as silage in the clamp will be minimal. It might appear to be a long way off, but it is imperative to take time, trouble and advice to get the agreement right. It also allows each party the opportunity to get to know one another and to be sure that they can operate in harmony.
Specific to business
A CFA must be individual to each particular business. The farmer does not have to be a landowner; he could be a tenant.
Briefly, a new bank account is set up – generally called the number two account – and through it all transactions for the new CFA and only those relating to it, pass. The farmer might, if necessary, provide security. For his inputs he will receive a set return (retention) a hectare (see table). The contractor for his inputs will receive a basic charge, usually based upon a per hectare figure (see table).
The net profit from the business is then divided between the two – the farmer retaining between 5% and 30%; the contractors being paid 70-95% as an additional charge. The levels of remuneration are set so that to make a good level of profit the contractor must produce a good net profit and thus the incentive to achieve high standards of management is maintained.
Practical level
In our example, on a practical level, Mr Johns farm would be used as the centre for the milking herd, Mr James for youngstock. Mr John would sell his herd to Mr James at valuation and Mr James would then hire it back to the new business at around 10% of that valuation a year. The two would discuss and decide overall policy between them and any particular areas of management, but husbandry – stock and crops – would be Mr James province and he would be responsible for labour, equipment and daily organisation.
The benefits to Mr John, the farmer, are retention of trading status and overall control of farming policy; reduced working capital requirements; good level of return with less risk than farming in-hand; while vacant possession of the farm – and the fiscal benefits – are maintained. He also avoids the potential difficulty of becoming a non-producing producer.
A CFA presents a possible solution in such situations as:
• Where the landowner/tenant wishes to retire from day to day management, but still wants to retain an involvement in the farming business.
• Where the landowner wishes to retain vacant possession and control over farming policy.
• Where its a non-profit making unit due to scale and/or management standards.
The benefits to Mr James, the contractor, are expansion of the current farming business; relatively low working capital requirement; no long-term tenancy commitments; no tenants ingoings; and potential for good levels of return with less risk than farming entirely on own account.
CFAs offer an opportunity for progressive farmers with good levels of technical ability to expand their farming activities and so spread fixed costs. In this situation a contractor can be an individual, partnership or farming company. *
Cost analysis
£/cow £/ha ppl £
Cow gross margin 800 1091 13.33 120,000
Less forage 136 185 2.26 20,350
Gross margin 664 906 11.07 99,650
FIXED COSTS
Water 23 32 0.39 3500
Electricity 27 36 0.44 4000
Office (admin of contract) 13 18 0.22 2000
Lime and general sprays 5 7 0.08 750
Sundry overheads 7 9 0.11 1000
Farm repairs 20 27 0.33 3000
Contractors basic fee 90 123 1.50 13,530
Landowners first charge 181 247 3.02 27,170
Total fixed costs 366 500 6.11 54,950
Divisible return 298 406 4.97 44,700
Contractor 253 345 4.22 7,995
Landowner 45 61 0.75 6705
TOTAL RETURNS
Contractor 344 468 5.73 51,525
Landowner 226 308 3.76 33,875
Administration
Book-keeping – all transactions flowing through the contract account should be recorded on a regular basis as for any normal farming business.
Ordering/paying for goods – the contractor can be given authority to order and sell in the name of the farmer. However it is usual that cheques will need to be signed by the farmer.
Procedure for setting up an agreement
• Appraise current business and ensure that contract farming is the correct route.
• Advertise the opportunity.
• Viewing day arranged and tenders requested.
• Vet tenders and interview short-listed applicants.
• Applicant appointed.
• Draft agreement drawn up in conjunction with solicitor.
• Terms negotiated and agreed.
• Agreement drawn up.
In certain cases some of these steps are bypassed, for example, if the two parties are already known to each other and the general principles agreed. The most important point is to ensure all items are negotiated and agreed and that a proper legally binding agreement is drawn up.
Farm return
Farm size 110ha
Cows 150
Milk quota 900,000 litres
All grass
Contractor and landowner amalgamate cows other young stock reared at contractors farm
Cow gross margin £800
Forage costs £185/ha
Litres per cow 6000
Contractors basic fee £123/ha
Landowners first charge £247/ha
Contractors return 85%
Landowners return 15%