Oct. 25 2011 08:03 AM

Nine must do's when bringing young producers on board

The author is the dairy development manager for Vita Plus, Corp., of Madison, Wis. He is a member of the board of directors with Citizens State Bank of Loyal, Wis.

With the current assets needed to milk cows, it is tough to bring new young producers into the game. Despite this situation, I am asked the same question frequently by younger dairy producers, who have established a starter herd, and well-established dairy producers, "How do we bring our herds together?"

The thought process involves "I want to get into the business" and "I want to bring someone else in." However, the right question to ask is, "How can the arrangement be set up to create fairness for both parties?"

The first step is to have two agreeable parties that believe they can work together. This process begins with a verbal understanding as a starting point. After that initial step, getting it in writing and seeking professional advice are two must do's. These partnerships may not necessarily be formal partnerships. However, the business arrangements should be drawn up with the help of an accountant, lender, and attorney. During this process, the following steps will need to be taken:

1. Both parties should sit down separately, first, to put their thoughts down on paper. Initially, consider what would be a fair business arrangement.

2. Each party should complete a current balance sheet. If you are not familiar with these documents, hiring the services of a financial consultant will make the process more understandable. This does not have to be shared immediately. But, eventually, the new person coming in should be quite open with the assets they have and any liabilities.

3. The current owner should review their cash flow to make sure they are relatively profitable before combining their herd with anyone.

4. Then, the two parties should sit down together to compare notes. Be prepared for an open discussion. This includes being open to ideas from each other. It should be mentioned here that if spouses are involved, they should be present at each discussion. Eight key discussion topics can be found in the sidebar.

5. An appointment should be made with the lenders of both parties. If there are liens on the cattle, the lender will want to know that cattle will be combined into one herd. Ideally, both parties should have cattle financed with the same lender. Lenders get concerned when there is mixed collateral with different lenders under the same roof.

6. At this point, an appointment should be made with an accountant. Balance sheets will need to be shared and projected cash flows completed. Preliminary cash flows should be run ahead of this meeting so the accountant has something to go by and knows there has been some thought put into the arrangement. Terms of the agreement should be discussed with the final version for the attorney to complete.

7. Work with an attorney who understands agriculture. Give this professional balance sheets, cash flows, and the preliminary agreement. No need to start from scratch. This homework should be well under way before the attorney meeting occurs. You will also save yourself money by not having extra hours to pay an attorney for the groundwork. Many attorneys will have template documents that they can use by filling in the blanks.

A good entry agreement always contains an exit agreement. No one likes to walk into a meeting when you are talking about working together but also talk about splitting. It does happen under good and bad terms. It is necessary to build this into an agreement when everyone is talking. Structured business models should be considered and discussed with the attorney such as a LLC (Limited Liability Company), LLP (Limited Liability Partnership), or other recommended entities.

8. Some people think there is no need to write things down. When they are written, everyone understands what is really being said. This is particularly helpful in the future when questions come up. Some think there is no reason to spend money on the help from accountants or attorneys. The more professional help you can get, the better ideas you will come up with.

9. Lastly, make sure you talk with others who have done this before. You can learn from their experiences to make a professional partnership.

Eight key discussion topics
Before comparing notes in Step 4, give consideration to these important issues:

a. How many cows and young stock does each party have on their balance sheet? These numbers will have to be tracked, once an agreement is completed, with ear tags if the cattle are to remain under separate ownership on one facility.

b. Is there adequate housing and feed available for all of the cattle? How about as the herd grows?

c. The incoming party may need to pay some rent to house their cattle, depending on the agreement. Monthly rents will range in free stall barns from $10 to $20 per head per month, tie stall barns $5 to $10 per month, dry cow barns at $2 per head and heifers at $2 per head. Charge includes upkeep and repairs.

d. The expenses should be split on a percentage basis. If 30 percent of the herd will be incoming cows, that is the percent of the expenses charged to the new party. Additional expenses can be charged to the incoming party or existing party if there are special costs such as genetic work. The expenses for the incoming party should not include other nonrelated expenses such as depreciation, interest, or principal the current owner has on real estate or personal property.

e. Providing both herds have similar calving intervals, the milk check can also be split based on a percentage basis. It becomes very complicated to try to use monthly testing, component differences, or specific milk pounds to decide on a milk check split.

f. If the incoming party is contributing some specific pieces of machinery, a financial consideration should be given to the monthly hours used to cover depreciation and a future replacement.

g. A consideration should also be given to a possible hourly wage due to the fact that the new party may only have 30 percent of the herd but is working full-time.

h. The agreement and earnings of the new party should show a reasonable return at the end of each month and at year's end. They need to be building their balance sheet to see that they are getting ahead. The exception may be in times of very low milk prices when breakeven or losses can occur. This needs to be discussed and recognized by both parties during the writing of the initial agreement.