A Viable Progression Path in the Dairy Industry

This report, put together by AgFirst and Federated Farmers looks at the progression path for those wishing to progress from a farm employee to farm owner, after concerns that this traditional progression is under threat, and the path to succession more challenging.

11 June 2012

5 minute read

Executive Summary

The New Zealand dairy industry has often been regarded as being innovative and progressive. This does not occur without having innovative and progressive people being involved in all phases and stages of the industry, whether that is on farm or off farm.

In the past, there has been a relatively clear progression path for those wishing to progress from a farm employee to farm owner, if that was their desired end goal. There has been some concern voiced in the industry that this traditional pathway is under threat, and the path to succession has become more challenging. This report explores those issues, looking at current and future pathways, pros and cons of pathways, and provides recommendations for those making decisions regarding career progression.

Sharemilking

Sharemilking has long been considered a vital step in the career progression path for young famers. 35% of farms are managed by sharemilkers (2009/10), 20% by Herd Owning Sharemilkers (HOSM). Although there has been only a minor reduction in the percentage of dairy farms managed by sharemilkers, there is a more noticeable trend in the declining number of HOSM, particularly in the South Island. Key reasons include higher debt levels on farm, more corporate farm ownership, and the difference in financial returns to the farm owner between using a herd owning sharemilker and a Variable Order Sharemilker or Contract Milker.

Sharemilkers have a track record of higher production (both herd owning & lower order sharemilkers).

There is a substantial variation in return on assets between farm owners and herd owning sharemilkers. While all parties accept there needs to be a greater return for the sharemilker, the differential is more pronounced at high payout levels.

Herd owning sharemilking delivers a good return on investment, although there is significant variability between years, and timing is important.

For herd owning sharemilking – this sector needs to continue to adapt. Market forces of supply and demand are at play, and the balance of power is currently in the hands of the farm owner. If the herd owning sharemilkers cannot accept there may need to be rebalancing of clauses within the traditional herd owning agreement, farm owners will make the decision to recruit contract milkers, lower order sharemilkers or farm managers.

There is no need to re-write the herd owning sharemilking agreement. Rather, if sharemilking is to continue, both parties must be open to making changes to the variables within the standard clauses. Recently this has included changes to sharing of Fonterra dividend, and grazing expenses for young stock. In the future it may include changes to the percentage spilt of milk income between farm owner and sharemilker.

There are still many valid reasons why a farm owner may decide to recruit a HOSM. These include: release of capital for other ventures, less day-to-day involvement by farm owner, helping to provide a progression/succession strategy for the farm business, medium-long term commitment, and avoidance of dealing with staff.

Equity Partnerships

Equity partnerships (joint venture farm ownership) are now an accepted option for progression in the dairy industry. While there is a significant amount of literature and expertise available regarding formation of equity partnerships, there is also a general lack of understanding amongst farmers about how they work. Whilst there are a significant number of farms owned by equity partnerships, there is little quantitative evidence about their success as a form of progression. Financially, logic suggests that in the long run, returns will be similar to those of the average farm owner (3-7% cash return on assets plus 5-10% capital gain per annum). In comparison, a HOSM agreement will generate on average a 20% return on assets, although there is a greater degree of annual variability in this figure.

Some key points for those considering equity partnerships:

Due diligence, for the farm and for the people involved
Do not over-leverage
Ensure adequate entry and exit strategies are included in the agreement
Opportunities to incentivise the minority equity manager through guarantees
Ensuring equity managers are receiving fair returns for their efforts, particularly transparency in wealth creation opportunities
Need for better governance structures
Need to develop shareholder agreement, business plan, and sound reporting and communication processes

Pathways

In 1996 seventy per cent of sharemilkers intended to purchase their own farm once completing their sharemilking career. By 2011 this had reduced to 55 per cent. The pathway to farm ownership has become more varied, and there are more options to choose from. The pathway to progression is no longer linear. This should not necessarily be seen as a negative factor. However with more diversity in the industry there is a much greater need for adequate due diligence on each individual opportunity. In many cases this is not occurring to a sufficient degree, and professional advice is not being sought.

Progressions opportunities are more varied and contracts are more varied. This highlights the need for better due diligence at an individual level, and the need to seek good advice.

Tools

As a result of this project, the following information and tools have been created for the industry to adopt, modify and use:

Pathway options – comparisons, pros & cons (for both young farmers progressing and farm owners looking at options)
Decision trees for both young farmers progressing and farm owners looking at options
Wealth accumulation table, for farmers assessing their options.

Recommendations

There is no need to make substantive changes to the HOSM agreement. Rather, herd owning sharemilkers will need to be more flexible in their approach to negotiating agreements. This may mean looking at varying split of income and expenditure away from the traditional 50/50 approach.
HOSM could be promoted more widely as part of an integrated pathway for farm succession. It may be beneficial to run some courses for those at the exit phase of their careers as to options available
Young farmers need to lift their business skills, in the areas of contract negotiation, due diligence and analysis of options.
Those entering into equity partnerships need to give more consideration as to how their shareholding percentage can be lifted in future years.
Promote the use of the decision trees and tables, and the wealth creation spread sheet that has been provided with this report
This report has provided a reference of useful documents. These documents should be held on a range of industry websites, to increase accessibility and awareness of information.
A summary document (based on this report) should be sent to all key industry participants, or the least made available on key websites.

June 2012