Thinking About Expanding Your Business?

by Ruder Ware
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Flyte Family Farm in Coloma has grown a lot over the years.  Not only has Flyte grown tons of crops, but Flyte has also grown its business, which has expanded to five greenhouses and 3200 acres.

Adam Flyte and his wife, Carrie, started their business growing corn, soybeans and fresh vegetables, which they sold at seasonal farm stands.  In 1999, Adam and Carrie expanded into hydroponics. But, expansion has been gradual. 

“As opportunities presented themselves and if it made financial sense, we expanded to meet demand,” said Adam, who built one greenhouse in 1999, one in 2000, two more in 2001, and another in 2004.  Along the way, Adam and Carrie also acquired three farms.

The Flyte Family Farm business expansion has been a success.  But, what makes a business expansion successful?  What should you consider when deciding whether to expand your own business?  What do ag lenders say about business expansion?  Here are some things to consider:

  1. Why Now?  According to ag lenders, the most important question is why do you want to expand?  “You need to ask yourself ‘What’s driving the need for expansion?’” says Rich Wilcox, an ag lender, who is vice president at BMO Harris Bank.

    Terry Johnson, vice president of ag/commercial lending at Pioneer Bank agrees, “it all starts with the ability of the producer to explain why” it wants to expand.     

    In a 2012 article on growth management strategies, David Coggins, executive vice president and chief banking officer at Investors Community Bank, wrote that, “operators have all kinds of reasons for growing/expanding . . .. It all comes down to finding out your own ‘why’ before developing a plan to get there.”

    In the case of Flyte Family Farm, the “why expand?” question was answered when Adam and Carrie saw demand for hydroponics that also fit the couple’s educational backgrounds in horticulture and agri-business.  That would be classified as a good reason to expand.

    What are bad reasons to expand?  “My neighbor is expanding or I read an article that says you need to expand to be profitable,” says Johnson.

    Going big doesn’t always mean becoming profitable and that leads to our next consideration.
  2. Is Your Current Operation Profitable?  Ag lenders will tell you there is nothing magical about business expansion that will make you more profitable.

    “If you have high operating ratios now, you’re probably going to have high ratios in expansion,” said Johnson, who indicates you should take a look at your existing operation and figure out how to become more profitable before expanding.

    If your goal is to increase revenue, then expansion should not be the first step you take.  Rather, Coggins writes, you should take “advantage of all the opportunities to ‘get better’ before you work on ‘getting bigger.’”

    Wilcox concurs, “Can you work to do better before you strive to do more?”
  3.  Have You Factored in a Drop in Commodity PricesWhen commodity prices are high, it is natural for producers to want to expand their business so they can make more money.

    But, Johnson cautions producers should not “make long-term decisions based on short-term economics.” Johnson points out that expansion is a 20 to 25 year decision that you may make when prices are high, but what happens when prices drop?

    Therefore, it is very important producers have a plan in place for dealing with a downturn in commodity prices.  If revenue falls short, how are you going to pay for the costs of expansion?

    “I would advise them to think it through and record their thoughts as part of a business plan which would include projections of best case, middle case, and worst case scenarios with odds of each,” says Wilcox.

    To protect against fluctuations in commodity prices, Flyte Family Farm diversified its products.  Flyte grows corn, soybeans, hay, and sweet corn. Flyte also has 800 acres certified as organic. Organic crops include: blueberries, sweet potatoes, sweet corn seed corn, and hay.
  4. Maintain Healthy Equity in Your Assets.  Johnson advises that businesses should “not borrow their last dollar in expansion.”

    “You may need to borrow additional money in the future to deal with unexpected costs.  If you have strong equity, you can get through the hard times.” Johnson says.

    Wilcox agrees that expansion may cause some issues that were not anticipated.

    Therefore, Wilcox asks, “is the business strong enough financially to absorb post expansion drop in equity or missed problems with expansion plans?”

    Adam Flyte acknowledges that managing your debt load is very important and that “working capital is key.”

    So, what percent of your assets is it smart to borrow against?

    From a collateral standpoint, “No more than 70% of the asset value on the high side. Lower levels might be smarter.” Wilcox said.  From an owner-equity standpoint, Wilcox does not recommend getting below 40%.

    Ideally, the goal would be a “debt to assets ratio of 50% or less” Johnson said.
  5. Make Sure Everyone is on the Same PageExpansion sometimes means family members or friends are coming together to boost business. But, your family or friends may disagree on their roles or how the business will be conducted.

    Wilcox wants to know, “Is the family and employee base on board with expansion plans?”

    Johnson relayed a story about a father who expanded his dairy business so he could farm with his five sons.  Later, when the operation was struggling, the sons admitted at a family meeting they didn’t like milking cows.  The moral of the story is communication between family members and business partners is critical.

    Expansion may also bring you additional responsibilities and headaches.

    Coggins writes that an expanded organization can test your “management talent” and “you need to ask yourself the hard question of whether you have the talent for taking on a bigger and much different job and a more strategic role in the organization.”
  6. Seek Out Trusted Advisors.   A good ag lender can be a helpful adviser.  Johnson notes that you should not run away from a lender who asks you lots of questions.

    “The questions are designed to help you understand whether expansion is appropriate for you.” said Johnson.

    Coggins writes “Your banker is going to look at a whole host of factors in considering your request for expansion, from working capital, to long-term cash flow assumptions, transition and construction phase issues, contingencies and having a well-documented plan.”

    Adam Flyte agrees that your ag lender can be a critical part of your success.  The lender is a “friend and a partner,” Adam relates.

Finally, be aware that legal issues can arise as you expand your business.  Such issues include: partnership or LLC operating agreements, construction agreements, estate and succession planning, leases and offers to purchase, and employment agreements, to name a few.  So, don’t be afraid to add an attorney to your circle of trusted advisors.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Ruder Ware | Attorney Advertising

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