Evaluating Investments in Value-Added Ventures in Agriculture

By: Erlin Weness, University of Minnesota Extension Educator in Farm Management
January 2002

Value Added Ventures

The number of joint ventures in agriculture has increased dramatically in recent years. Joint ventures in corn sweeteners and ethanol, soybean processing, alfalfa or sugar refining, poultry, hogs and dairy production are currently in operation in Minnesota. Value added ventures have a common goal, the addition of value to the products currently raised by farmers. It is an effort by farmers to get a little farther up the “farmer-to-grocer” food chain and capture more revenue.

Types of Entities

Each value-added venture may have a different type of business organizational structure. The most common business operation structures include partnerships, corporations, limited partnerships, cooperative or limited liability companies. Thorough investigation should be given regarding tax, liability, resale and control issues of the structure when considering investment in a value added venture.

The Key to Success

The key to success when investing is to find a profitable business with limited risk. The remainder of this publication will point out items to consider which can contribute to the success or failure of the joint venture.

What to Watch Out For

Value added ventures are usually quite risky. Many are newly formed businesses with limited experience in the industry.

Value added can be a viable concept if you can tolerate the financial risk. Sometimes the risk can exceed your original cash contribution. A “value added” venture can soon become a “value subtracted” financial disaster if things don’t go as expected.

When considering value added ventures be sure to look at the worst case scenario and project what happens to you if things go badly for the venture. Prices, market conditions, production and management difficulties, construction delays, regulation roadblocks and environmental issues can cause major problems for starting businesses.

Make sure the value-added venture has sufficient capital. Undercapitalized businesses have no flexibility and shortfalls can kill the business. There is strong competition in most food-related industries today. Your venture must have the financial staying power to weather several years of heavy competition or unforeseen financial reversals.

Determine the qualification of the management staff. Make sure those on the management team are trained, experienced and have successful track records.

Don’t underestimate the complexity of government regulations and your personal liability.

The time and cost of complying, and the liability from not complying, can be enormous. If asked to serve on the board of directors, understand that you may be taken to court personally for your actions and that your personal finances may be at stake. If you hire an employee and they make a mistake, you may be held liable.

Make sure decisions regarding plant location and feasibility are based on fact and reason rather than emotion and politics. A good plant site will usually be near raw material sources and have easy access to transportation lines for product dissemination.

It may be wise from a risk and profitability standpoint to invest in an established, proven entity rather than a start up company. However, a start up company in your area can give you a stake in providing economic revitalization and job development in your area.

Ten 10 hazards for new-venture co-ops

Plant specifications are not met.
Construction contract problems, such as delays and overruns.
Lack of serious commitment by owner-members.
A poor location can put the business in a non-competitive situation.
Market projections that are overly optimistic.
Unrealistically low operating cost projections that cannot be met.
Making faulty marketing assumptions.
Hiring poor manages.
Starting with an excessive debt-to-equity ratio.
Led by an outside promoter rather than local owner-investors.

--- Source: St. Paul Bank for Cooperatives

Questions to Ask Before Entering a Value Added Company

Does the product already exist? If so, will your product be competitive and marketable? Can your venture compete with the big boys in the industry? Competitors may attack your efforts using whatever means they can.
Does your company have only one product or are they diversified to lessen risk?
Are profit and return projections realistic and positive? Are projected returns on investment high enough to pay back interest plus principal in a reasonable time? That may require a 20 to 30% return.
What added financial or liability risk will this add to your business? How much financial liability do you have beyond your original investment?
Does the company have contracts signed with buyers of the product? Do they have input costs locked in? If not, think twice.
Did an independent consultant with an excellent track record do the feasibility study?
Do you completely understand the type of business organizational structure; it’s tax and legal implications?
If you want out of the venture, is it clearly stated how it may be accomplished? Will anyone want to buy your shares if you want to sell? Can you pass your shares on to your heirs without problems?
Is the board of directors a diversified group of independent thinkers and business people? Savvy and trained business people will usually perform better than a “good old boy” board.
Are the legal contracts and agreements you sign clear and comprehensively written so all parties understand obligations and commitments as well as termination options?
What is the worst case scenario? How much money or sleep can you lose if you enter this venture and the worst happens? You may wish to use only “in hand” venture capital (money you can afford to lose). It is risky to borrow money to finance a high-risk venture.
How will it be organized for tax purposes? Will you have a taxable gain or loss and how and when will it be reported on your tax return?
How will the tax organizational structure impact your income tax situation? Will you have passive losses that are not deductible?
What type of financial reports will be prepared and distributed and how often will they be available? Are they reliable?
What vehicles of communication have been set up to keep shareholders informed of company actions?
Is the management team competent? Have they had previous experience and success? A misjudgment in placing the management team can jeopardize the entire venture. Hire the best.
Are the promoters of the project investing and taking risk or are they merely seeking outside capital funding to secure a plant to operate?
Large companies spend huge dollars to determine profitable ventures. If your project is so good, why isn’t someone else doing it?

If you can get satisfactory answers to these questions, the odds for success are in your favor.

Don’t let “Co-op Fever” emotions take over. Let facts help you make a decision rather than emotion.

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This page was created on 01/31/02 by Erlin Weness with assistance from M. Werner.