AgDM newsletter article, September 2007

Energy agriculture - farmer investment decisions

Don HofstrandDon Hofstrand, retired extension value added agriculture specialist, agdm@iastate.edu

Seventh in a series

If I start a value-added agricultural business, will farmers invest in it?  This is the uncertainty faced by many farmer entrepreneurs attempting to fund a value-added business. A long-time consultant friend of mine told me, “I can find business opportunities for farmers, but I can’t anticipate if they will invest the funds needed to capitalize the business.”

To shed light on this topic, the Ag Marketing Resource Center funded a study to survey farmers about their investment decisions. The Iowa Farm Business Association cooperated with us to randomly survey their farmer members. During the spring and summer of 2006, ninety completed surveys were obtained. The information below is based on the results of these surveys.

Assessing an investment

The farmer respondents ranked the importance of several factors commonly used to assess a business investment. The farmers considered all of the factors important. But some were more important than others. Management of the business rated the highest. Leadership of the project and product demand followed. Interestingly, the estimated return on equity ranked the lowest. The ranking may indicate a certain amount of investor sophistication. An awareness that the first five factors need to be in place before the return on investment will be realized.

The importance of investment attributes

We attempted to identify various attributes of an investment and determine the importance of these attributes in the farmer’s investment decision. Four general investment attributes were analyzed.

1.   Location - This attribute focuses on the potential impact of the business on the local community and surrounding farms.
2.   Familiarity -This attribute focuses on the farmer’s knowledge and comfort level with the business and industry.
3.   Control - This attribute focuses on the importance of control of the business by local farmers.
4.   Profitability -This attribute focuses on financial return issues.

The survey provided descriptive statements for each of the general attributes. The farmers were asked to respond to these by indicating the importance of each statement. The average response of the farmers is shown in Table 1. The respondents reported that all of the attributes were important. However, considerable variation existed among the attributes.

Table 1. The importance of various investment attributes by investment decision.

The farmers’ past value-added investment decisions provided the following categories. The responses were categorized by farmers who invested in a value-added business and those who did not.

Respondents cited the positive effect on local crop and livestock prices and the rate of return on investment as the two most important attributes. Improving farm profitability by increasing prices was just as important as the rate of return on the investment in the business. Moreover, combining these two factors with the positive local economic impact of an investment creates a powerful motivation for farmers to invest in local agricultural processing businesses.

The degree of familiarity with the business and its industry was also important. However, familiarity with the business does not necessarily mean an intimate knowledge of the business or the industry. Rather, it indicates a comfort level based on multiple contacts with the business and the industry.

Local control of the business was also important. However, partnering with existing businesses to access expertise and capital ranked slightly higher than local control.
Rate of return on the investment was the most important profitability attribute. Liquidity of the stock also rated very high. Because value-added businesses are usually not publicly traded, finding a buyer for your stock and getting full value for it is often difficult.

Whether the returns are paid in cash or reinvested in the business was not ranked as very important. However, my personal experience indicates that this is becoming a point of contention for farmer investors. When earnings are reinvested in the business and the stock is illiquid, farmer investors feel their investment provides little return, even when the business is doing well.  

Past investment decisions by education

We asked the respondents about their investments over the last ten years. These results are shown in Table 2. Thirty-nine percent of the respondents reported investing in a value-added business. Much of this investment was probably made in the emerging bio-fuels industry. Fifty-two percent reported investing in their farm business.

Table 2. Investment history of respondents by education

The level of education played an important role in the value-added investment decision. Fifty-eight percent of the respondents with four years or more of college invested in a value-added business. Conversely, only nineteen percent of those with high school or less invested. Education played a smaller role in the other types of investments.

Choosing among investment opportunities

The survey asked respondents how they would hypothetically spend an extra $50,000 among a specified list of investments. They were asked to allocate the money among the investments in Table 3. As expected, the largest investment (37 percent of the funds) was in their farming operation. This was followed closely by traditional investments like certificates of deposit, stocks, mutual funds, etc., at 35 percent. Value-added business investment ranked third, but commanded a respectable 28 percent of the total investment. So the willingness to invest in value-added ventures is quite good when funds are available.

Table 3. Allocation of funds across alternative investments by age

Of greater interest was how the investment decision changes when respondents are categorized by age. Those under 50 years of age invested about half of their funds in their farm business while those over 60 invested slightly over a quarter of their funds in their business. These results are consistent with the shorter business planning horizon of older farmers.

The results are similar for value-added business investments. Recipients under fifty invested over one-third of their funds in value-added businesses while those sixty and over invested only 17 percent. This may be caused by the longer time-frame needed to generate returns from start-up businesses versus the immediate potential returns from fixed income and stock market investments.

It may also stem from an investment attribute discussed earlier. Investing in value-added businesses to increase the local demand and price for crops and livestock increases their farm income. Because farmers under fifty years of age have a longer business planning horizon, they can take more advantage of these higher prices.

The change in the type of investment appears to occur at about sixty years of age. This occurs because the investment allocations of aged fifty to fifty nine were much more aligned with those aged less than fifty than those sixty and over.

 

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