Even the most fiercely independent arable farmers are taking a fresh look at collaboration – and that is offering a genuine “Fresh Start” opportunity to those with drive, determination and the will to succeed.
A decade ago, collaboration was not seen as a particularly attractive option but changes in the marketplace and the remorseless demand to cut costs while maintaining output and quality has caused a rethink.
Several factors have driven these changes:
- A better understanding by farmers of how joint ventures work
- The recent low commodity prices forcing the labour and machinery costs to be reviewed
- A shortage of skilled young professional crop management specialists in the industry
- The increase in fuel and power costs
- The age of the farmer and the lack of motivation to be involved in the administrative and regulatory aspects of a farming business
- Single Farm Payment (SFP) decoupling crop production
To fully assess the opportunities available the basic requirements of any joint venture must be understood. Then the many possible structures can be assessed to suit different situations.
In general, joint ventures have been constructed to avoid the formation of a partnership or a tenancy and to ensure that the farmer is considered by Her Majesty’s Revenue and Customs to be running a farming business. This has been tested by the Revenue. It needs to see the landowning farmer to be fully involved in the day to day decision making of the business. The main benefit at stake is Inheritance Tax relief on the farmhouse, usually the largest asset owned by a farming family. If this is lost as a result of a badly constructed agreement or deviating from the written agreement, 40% of the value of the house can be at stake.
Unfortunately the Single Payment Scheme has added complexities to the development of joint ventures because of the basic requirement to be in occupation of the land for the 10 month period.
The basics of a well structured joint venture should consist of in-built returns to the parties to enable them to be automatically rewarded for effort and expertise at differing profitability levels.
All who are considering joint ventures should learn the following basic business principles before contemplating an arrangement. Too many people have attempted to build empires in the past, only to resort to downsizing when things didn’t really work out. Main lessons to take on board are:
- The laws of marginal costing or marginal economics. In other words what is the return from the last few acres, not the average of the total acres
- The law of diminishing returns which is a relative reduction in returns for an ever increasing amount of input
- Partial budgeting to financially assess a change in the business by quantifying the costs saved and additional income compared with additional costs and less income
Although there are a multitude of possible structures, all can really be categorised as either share farming or contract management.
How share farming works
The landowner and the farming contractor agree to split the variable costs and sale proceeds in a particular ratio based on the relative values of their contributions. Here’s an example. The landowner will contribute:
- Land and buildings based on their rental value – £24,000
- House – £4000
- Grain stores – £2000
- Insurance of standing crops – £1000
- Management – £5000
- Interest on 20% ownership of machinery (loan) – £800
- Total – £36,800 (48%)
The contractor will contribute:
- Labour and machinery based on contracting fees – £36,000
- Management – £3000
- Telephone and office – £800
- Total – £39,800 (52%)
Therefore the inputs, drying costs, insurance of grain and crop sales are split on the % ratio and the SFP can be nominally split on the same ratio.
Either party can claim the SFP as they will both be in occupation of the land. Each party run their own separate businesses with their own VAT registrations, accounting and tax assessment.
Share farming has not been popular in the arable sector in the UK. The challenge for young professional farmers is to develop a methodology whereby a young entrant can build up equity in a farming business which is not possible in a contract farming agreement. For example, in the figures above the farmer has retained a 20% value in the machinery which the contractor will gradually purchase.
Contract management or contract farming agreements
A contract farming arrangement is essentially a farmer using the services of a contractor or another farmer to supply labour, machinery and management. The contractor will receive a set fee for the services provided and a bonus as a percentage of the calculated surplus from the venture. The arable results are calculated in a memorandum joint venture account which is not an entity such as a company or partnership but an arithmetical calculation to establish the bonus for the contractor.
- Example of memorandum account £/ha
- Crop gross margin – £247
- Single farm payment – £197
- Fixed costs agreed to be included:
- Insurance of crops paid by farmer as owner of the crops – £10
- Electricity for drying grain – £14
- Number 2 account interest – £12
- Contractors basic fee – £197
- Farmer’s retention – £173
- Harvest surplus – £38
- Split contractor 80% – £30
- Split farmer 20% – £8
- Second split of 50% each above total return to contractor of say £300 – nil
- Total contractor – £227
- Total farmer – £181
Most arrangements in the past have been centred around the Arable Area Payment (now SFP) being the net return to the farmer and both parties need to fully consider the effect of the inevitable reduction in SFP over the forthcoming years. In the above example when the SFP reduces below £173/ha the arable gross margin is contributing to the farmers’ retention.
Several variations have developed over the past few years. However care must be taken to ensure that the farmer is seen to be fully involved in the management of the arable business for taxation purposes.
- The single farm payment (SFP) can be left out of the equation with the farmer not taking a farmer’s retention. As the SFP reduces over time the return to the farmer will reduce
- The contractor can be given the option of purchasing the grain at harvest
- The contractor can fund the inputs on an unsecured loan however this is normally tied in with an option to purchase the grain therefore providing security
- Entry and Higher level Scheme payments are usually kept outside the arrangement
- Contractor paid quarterly in arrears or sometimes annually in arrears.