Have you thought about raising money from your neighbors to fund your farm? What about from friends and family? From your town, community or group of like-minded individuals? From anyone who is willing to give (i.e., “crowdfunding”)? How can you go about raising the money, and what should be considered?
The recently published Guide to Financing the Community Supported Farm, now available for free download, outlines the legal, accounting, environmental and social ramifications involved in alternative farm capitalization arrangements. The 13-chapter illustrated guide was informed by experienced farmers and knowledgeable legal and financial professionals, and provides details about such mechanisms as the promissory note, the owner-financed land sale, equity financing, share leases, multi-year CSA shares and other tools that Vermont agricultural businesses can use to partner with community members to establish and grow their operations. Also included are four case studies written by farmers who have tested these and other alternative ways to source capital for farm operations.
If you are exploring community financing for the first time, below are some options and key considerations related to each. Click on each section below to read chapters of the guide for more detailed information about each particular topic.
If obtaining a real-estate mortgage or enough financing to fund a land purchase is difficult, the property seller might consider acting as “the bank” to extend you a loan to finance the land purchase. A land contract is very similar to an owner-financed sale, but in a land contract, the buyer does not gain full legal title until all of the payments are made.
Key consideration: The IRS views owner-financed sales as “installment sales” and a portion of each payment is usually treated as principal and a portion as interest for tax purposes. Also, unless certain exemptions apply, the IRS requires that a minimum interest rate be set for paying back the owner-financed sale loan. See Chapter 3 of the guide for more information.
There are various forms of partnership, and these agreements involve careful planning and consultation with legal and accounting professionals. One particular model, the “land buyback model” is simple in that it does not involve the formation of legal partnerships. The model can be particularly attractive to new farmers who are ready to manage their own land, not immediately ready to purchase it, but will be ready to purchase within five year’s time. In this model, the “investor” purchases the land with the intention of reselling some or all of it to a partnering farmer within a set period of time, e.g. five years. The farmer starts out leasing the land or operates on another parcel, builds equity, skills and experience with the intention to purchase the land during the specified period of time.
Key consideration: An Option agreement can supplement this kind of arrangement to ensure the farmers that they will have the legal right to “buy out” the farmland investor. Without an Option or similar mechanism, the farmers risk not being able to acquire the farmland for the long-term, despite any verbal understanding or high hopes that might have been present at the start of the agreement.
This is the basic legal agreement that serves as the loan contract between any two parties. Similar to lending institutions and borrowers, any individuals can draft a customized promissory note to outline the terms of a loan, including how it is to be re-payed.
Key consideration: In most cases, “zero-interest loan” is an oxymoron to the IRS! In community financing arrangements, it is often the desire for community members to loan money at low interest rates to support the business. However, “Below-market Loan rules” must be followed in order to legitimately classify a transaction as a loan instead of a gift. For sample promissory notes, see the Guide to Financing the Community Supported Farm appendices.
Now we’re venturing into the world of venture capitalists, angel investors, and selling stock or ownership shares in a company. Equity financing is rarely used by farmers, because it involves giving up an ownership stake in the business. Equity investors rarely desire to fund farm businesses because there are few routes of “exit” or cashing in big on the business when it sells. However, equity can be a solution if there is a particularly profitable innovation from the farm that needs big financial backing.
Key consideration: Farmers might want to consider including provisions into the equity financing agreement to buy out the investor by allowing future re-purchasing of equity.
This is debt financing with a twist, where a baseline interest rate is set, and the lender is guaranteed an additional portion of the re-payment based on a percentage of the businesses gross revenue. It can give the business the opportunity to base loan repayment more on sales and less on a fixed expectation from the lender for a regular payment.
Key consideration: Revenue-based financing is likely not appropriate for start-up stage businesses or those with low or unpredictable profit margins (net annual income above expenses). It is generally wise for these types of businesses to reinvest profits back into the business to cover future operating or capital expenses or pay off principal for other loans. Revenue-based payments can detract from the business’ ability to pay down principal or make investments in farm infrastructure in a timely manner.
The multi-year CSA farmer sells CSA shares that might be worth more than the total food supplied in any given season. For example, where the typical CSA share is sold for one season supply of $450 worth of produce, a multi-year share could be sold for $5,000 and the purchaser has the option to “cash in” on the purchase at their leisure over the course of several years.
Key consideration: While this might seem like a loan, it is not. The multi-year CSA share is the same as a one-year CSA share by which food or services are pre-purchased. Unlike a loan where the transfer of principal from one entity to another is not taxed, the transaction of the multi-year CSA share purchase can be a taxable transaction. In other words, the whole $5,000 share could be treated as taxable income to the farmer in the year it is obtained.
The share lease can be an excellent way for farmers in a lease situation to partner with land or farm owners to share the costs of producing. The share of revenue to each party usually mirrors the share of costs that are contributed. While it can be complicated to account for all costs contributed, it can be an easy arrangement to set up, in that no new business entities, such as partnerships, need to be formed.
Key consideration: A share lease is a conventional lease agreement with a twist. All provisions to a lease agreement should be included and considered, such as insurance responsibilities of each party, who will be responsible for what type of maintenance and property improvements, etc.
#8: Last but a MAJOR consideration in crafting creative financing arrangements:
Alternative or Community or Creative financing is no different from traditional!
Acquiring capital is acquiring capital, and no matter the source, it behooves the farm business owner to engage in detailed planning to determine the most appropriate and efficient use of capital. Especially in new farm operations, under-capitalization is a common pitfall, where capital, be it in the form of cash, infrastructure, livestock, equipment, is insufficient to enable the business to produce enough income to cover near-term expenses or obligations. This invariably sends the business owner searching for more financing, and with each arrangement, there are financing costs. If capital is used inefficiently, this can be a dangerous treadmill.
A well-informed plan should clarify the business owners’ goals and expectations. Having a well-informed plan should help clarify what forms of capital are absolutely necessary and appropriate for certain stages in business. Having a well-informed plan should clarify the realistic income producing potential and timeline for producing income related to each capital asset. The plan for how resources will be deployed efficiently should look no different if the money is coming from USDA Farm Services Agency, a local bank, or grandpa.
ON TO CROWDFUNDING!!!
No discussion of community financing is complete without mention of recent developments in the arena of “crowdfunding.” Crowdfunding is where an entity reaches out to many individuals for small amounts of money to meet a specific fundraising goal. Up to now, crowdfunding has been donations-based—the business gets a donation in the form of money from anyone willing to give, and gives specified gifts, rewards, incentives, etc back to each financial donor. Kickstarter.com is an example of a donations-based online platform. Several Vermont based food businesses have used or are currently using crowdfunding to raise funds:
Beet vinegar project in Starksboro (current)
On-farm renewable energy in Barton (current)
Kickstarter is just one example of online crowdfunding platforms among many. One Vermont-based crowdfunding platform is on the cusp of being launched. Three Revolutions, plans to serve farms, food businesses and their communities.
Up to now it has been a violation of federal securities laws to use online crowdfunding platforms for brokering direct loans and transactions of investment capital between individuals. But the recently passed federal JOBS act includes a crowdfunding provision that amounts to a complete game changer. The Securities and Exchange Commission has been given 270 days to specify the exact nature in which the provision can be implemented (don’t rush to open up your town stock exchange just yet), but the law states that sourcing of investment capital by small businesses from ordinary individuals via crowdfunding platforms will now be legal as long as specific guidelines are followed. For example, the funding portals will be responsible for providing adequate disclosure about the nature of the business or investment. Businesses will be able to raise up to 1 million dollars using crowdfunding, and individuals, regardless of their “accredited investment status” will be able to invest or loan small amounts of money to these businesses.
Many websites, such as Crowdfunder.com, are already adapting to the recent passage of the JOBS bill, and eagerly anticipate the final SEC rulings associated with the bill.
It is still uncertain what drawbacks will arise from the multitudes of people transacting small amounts of money via the internet. However, it is clear: investment-based crowdfunding enabled by the recent JOBS bill will add one more option to the community financing toolkit, making community financing more interesting, real and potentially useful to farmers than ever before (or at least since the original federal Securities and Exchange Act was set into law in 1933!)