Getting the green light: CoBank business development officer discusses essential planning needed to finance an added-value cooperative - economic considerations for agricultural businesses planning added-value operations

Rural Cooperatives, May-June, 2002 by Jeff Kistner, Catherine Merlo

Editor's Note: Kistner is a business development officer with CoBank in Denver, Colo. This article is based on a presentation he made at USDA's most recent Agricultural Outlook Forum. He can be reached at (800) 346-5717, extension 2025 or at jkistner@cobank.com. If you have questions regarding feasibility studies or business plans, contact Kirk Martin at (303) 740-4060. Merlo is a writer and public affairs specialist based in Bakersfield, Calif., who is a frequent contributor to this publication.

Is your agricultural organization considering a start-up venture that can add value to the company's business operations?

You're not alone if you are. Over the past 10 years, hundreds of agricultural businesses across the United States have ventured into added-value operations, from food-producing enterprises to operations that produce renewable fuels derived from soybeans and corn. Some have been successful, some have not.

As a major provider of financial solutions to rural America, CoBank has looked at many added-value ventures in the last decade. We've been involved in financing ethanol and diesel, pasta, corn-milling, turkey- and beef-processing plants. We know what steps must be taken to ensure that these added-value ventures succeed. Using ethanol as an example, here is a road map to launching an added-value venture.

The first steps

The first step in determining whether the project has merit involves the added-value equation, or balancing the elements of the proposed venture. To calculate the equation, a lender lines up the project's strengths, weaknesses and uncertainties in a column format. In order for the project to proceed, its strengths minus its weaknesses must be greater than its uncertainties. If that equation holds true, the project can proceed to the next step--attracting financing.

Lenders look at five credit factors:

* Capacity--the repayment capability.

* Capital--the financial condition or the balance sheet of the business.

* Character--the management.

* Collateral--the quality and value of the secondary repayment source. The collateral in most added-value propositions may only be used for the designated purpose and, therefore, is considered a special-use asset.

* Conditions--the purpose, amount and requirements to operate the business. Lenders look at this credit factor from two perspectives: the external and the internal. External conditions cover such areas as the economy, whether there is enough production in the area to support the venture, demand for the output, and government regulations. Internal conditions include the loan covenants and the business's ability to meet a minimum set of financial standards.

Once these credit factors are known, you can move to the start-up stage for your added-value project. You must follow each stage in order. If you jump ahead, you'll have problems and you'll end up backtracking.

You should start with an initial meeting, which is the official formation of the venture. Several questions must be answered at this meeting:

* Is there a group of producers willing to invest in, or to be part of, this business?

* If so, have you formed your organization? Will it be structured as a not-for-profit organization, a coop, a C or S corporation, a limited liability corporation (LLC), or maybe the new Wyoming Co-op?

* Have you secured seed money? This means more than just applying for a state or federal grant or finding an economic development person to do some work for you. It means the owners must make an initial cash investment that the venture can apply towards research and development.

Moving on to a feasibility study and a business plan

Once the seed money is secure, you must conduct a feasibility study. This outlines the global picture, which doesn't necessarily refer to an international scenario. It may be local, regional or national, depending on your targeted market and the proximity of your competition. The feasibility study addresses such issues as how your organization will fit into the global picture and what you must do to be competitive. There are five components of a feasibility study:

* Technology

* Management

* Markets

* Economic conditions

* Your financial projections

These five components are basically what USDA requires for an analysis for its Business and Industry Loan Guarantee Program.

The feasibility study addresses supply and demand characteristics. It discusses the importance of a steady supply of raw materials and reviews market share, pricing trends and sensitivities. It outlines your cost competitiveness and determines if you will be a high-cost or a low-cost producer. It answers such questions as: Can you get into the market? Can you enter into contracts? Are your financial projections realistic? It also outlines scenarios for worst-case, best-case and what-if situations. Finally, it details your capitalization structure.

The feasibility study is one of the most important steps you can take on your way to becoming a successful added-value venture. Yet, some organizations that are willing to spend $15 million on a new plant skip this step because they are reluctant to spend the $20,000 to $40,000 required for a feasibility study. Still others rely on people who will gain from their involvement in the added-value venture to conduct their feasibility studies. Instead, use unbiased, third party assistance; an impartial feasibility study should be your goal.