January 11, 2017 | Source: Oregon Tilth | Format: Lessons Learned

Lessons Learned: Understanding Financial Strategies for Organic Transition

In 2015, the Organic Trade Association reported organic product sales of $43.3 billion, up 11 percent from 2014. Based on these numbers, the case seems simple: transitioning to organic agriculture could be a viable opportunity for farmers making investment decisions to increase economic resilience in their farm businesses.

However, transitioning producers face many challenges. Oregon Tilth and other support institutions are working to provide technical resources and assistance to address issues around production practices. Unfortunately, financial support structures for transitioning producers remain few in number but critical to bridge the economic gap during a period of lower income and higher costs. Farmers are often unable to make the case to traditional lending institutions that the risk-reward of investing in organic production is fundable.

Loans and transitional premiums—an organic market value price offered to farmers in transition that follow organic farming practices, but are unable to be certified organic until the end of a three-year mandatory wait period—are two market-based strategies to support the financial needs of transitioning producers.

LOANS

Craft3 is a nonprofit Community Development Financial Institution lender that provides loans to businesses, nonprofits and individuals, including those without access to traditional financing. Brad Hunter, senior business lender and vice president, maintains that opportunity in the form of future price premiums is not enough to convince mainstream lenders to invest in organic transition. “You need a body of evidence that goes beyond sales prices,” he said. “Without a strong history of data about yields, production costs and labor increases, a lender is always going to trend toward conservative numbers that exclude a best-case scenario in favor of the worst.”

Adding to the challenges, Hunter sees many farmers pursuing financial support for transition while in a weakened position. “You have someone who has to present a solid case for investment rooted in real data that is simply not there,” he said. “Attach to this that the farmer is often applying for a loan when sales are in decline and operating costs on the rise, and it’s not a favorable picture for any lender.”

However, Hunter shared steps any farmer can take that will make a difference with any lender:

  • Present clean books, even if you’re losing money
    There is no substitute for a quality ledger and accurate recordkeeping. It will be a non-starter to approach a lender for any loan with poor bookkeeping.
  • Sophistication in financial reporting and projections
    Thoughtfulness and preparedness can outweigh the rosiest of projections for many lenders. Being able to share a solid profit and loss statement (P&L) gives an intimate portrait about a farmer’s ability to manage revenue, costs and smart approaches to challenges that came up along the way.
  • Create a comprehensive cash flow projection
    Lenders want to see a statement of cash flows that makes sense. Call out all assumptions where appropriate and highlight future capital expenses such as new equipment and labor costs. It’s critical to show a firm handle on costs for inputs, changes in farming practices and market considerations, like finding a buyer for crop “seconds” that can’t go to a retailer.
  • Present an upper and lower band with real data for yield projections
    It’s important to do the homework and share quality data—even anecdotal
    information from a well-established mentoring farmer can be helpful—around yield projections. A lender confronted with poor data will always assign a conservative yield estimate.

TRANSITIONAL PREMIUMS

Hunter highlighted the opportunity for a shared-risk approach that brings food companies and lenders together. The ability to demonstrate commitment of a price premium from a buyer during the three-year wait period is a huge asset for a transitional loan applicant.

A few companies are supporting transitional growers through price premiums. For them, it’s an investment in maintaining a healthy supply chain of domestically grown organic crops for their certified food products. The New York Times reported that Ardent Mills pays a premium to transitioning farmers prior to organic certification in order to support continued growth of specific crops to back up their customers organic food products. And Kashi, as reported in TakePart magazine, provides farmers a premium for crops that are then marketed as certified transitional in coordination with their certifier, QAI.

Transitional premium payments are largely uncharted territory for a sector that has grown at an unprecedented rate in demand but lags behind in production.

One percent of U.S. farmland provides organic crops to all possible markets. Sufficient supply of organic crops is a direct threat to many food companies dependent—exclusively or in part—on organic product sales. However, companies like General Mills, Nature’s Path and others are applying market-based strategies to simultaneously promote growth in organic acreage and address financial support structure gaps for transitioning farmers.

The Organic & Non-GMO Report highlighted how Clif Bar created a seven-year contract with a fig grower to purchase all of its crop once certified organic. And while the burden of transition costs was still on the grower alone to finance, a guaranteed buyer for all of their product after receiving organic certification enabled them to make up the costs within the first four years of the contract.

Whether a transitional premium or a long-term contract, any strategic partnership that has big unknowns (e.g., yields and quality) and strong expectations (attainment of organic certification) still require a few core practices for a successful partnership. Research specialists at the University of Vermont highlighted core elements for a positive long-term relationship between any grower and buyer:

  • Regular communication:
    A transitional premium or long-term contract is an investment of one company in another in hopes of a mutually beneficial future. It is critical to establish consistent communication and progress reports, without creating undue burden for either party, to avoid surprises.
  • Transparency:
    Risks cannot be completely eliminated but can be relieved through the development of trust and transparency. Regular communication keeps both sides well informed about the status of the partnership and allows for either side to openly discuss problems or unmet goals.
  • Establishing a sense of partnership:
    Growers and buyers will be able to work together on solutions and strategies for organic production. As each side gets a better understanding of the other’s needs and perspectives, it allows the entire organic supply chain to innovate and effectively respond to future challenges.

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