Hello folks, thanks once again for joining us for this rural entrepreneurship video series. My name is Andy Larsen, and I’m a farm finance consultant with the Food Finance Institute, which is part of the Institute for Business and Entrepreneurship within the University of Wisconsin System. Thanks very much to my collaborators at University of Wisconsin Division of Extension for making this video series possible. In this video, we’re going to talk about financing options for a rural food or farm business. We’re going to spend most of our time talking about traditional banks and traditional lending, but also bring up a number of options that are a little bit more non-traditional, if you don’t want to use a bank or you can’t. 

Let’s begin our discussion with some of the basic types of commercial loans that a farm or a non farm business might pursue from a traditional bank or financial institution. I kind of consider these going into three basic buckets, the short term loans or line of credit bucket, the intermediate term loan bucket and the long term loan bucket. The short term and lines of credit bucket usually have an amortized life of about a year, sometimes a little less, sometimes a little more, but those tend to be used for operating capital on farms. It’s for the current growing season for non farms that might be the current marketing season or whatever other delineation that that business has. These are often secured by a UCC filing, Uniform Commercial Code, filing with the Secretary of State. These are often referred to as a blanket ag security agreement or a blanket commercial security agreement. And that’s basically telling the secretary of state that the business in question has secured this loan with their non real estate assets, sometimes referred to as chattels. 

Intermediate term loans are usually amortized over the course of two to about 10 years. These loans are very frequently used for machinery, like tractors or heavy food manufacturing equipment, that kind of thing. Trucks, other over the road vehicles, that kind of durable equipment. These can be secured by a UCC filing as well, but often these are bigger, more high dollar types of items. So they usually will have a serial number or a VIN number that can be collateralized against the loan written against in order to do that specific item. Long term loans are typically the realm of mortgages, they are going to be from about 10 to 30 years in length, and they’re usually used to finance real estate, or improvements to real estate with a very few number of exceptions. 

There are a lot of banks out there, and oftentimes, they look pretty similar. So let’s talk a little bit about how you choose which bank you can approach when you’re looking for your first loans. Oftentimes, people are going to go to the financial institution where they have an existing relationship, or an existing family reputation. For example, if it’s a small town and your family has banked there for generations, that’s useful because you’re sort of a known quantity. If you or your family has been there for a long time, they know your financial patterns, they know your level of reliability, and they know your reputation around town. It can make it a little bit easier to get into a loan and form a relationship with that financial institution. 

If that is not an easy reality for you, you might want to search out a bank by their specialty. Not every bank is going to specialize in agriculture. Not every bank is going to specialize in entrepreneurship. So you might want to look for banks that are specifically advertising that they work with farms, that they work with family businesses, and that’s written on their website, on their literature, and they have loan officers to support those pursuits. 

An easy way to determine whether or not they’re going to do this is what kind of outside partnerships they have for making loans. The farm services agency or SBA is a very common partner for joint financing and loan guarantees in agriculture. The SBA, the Small Business Administration is a very common partner in non farm entrepreneurship and small business. 

The other thing you’re going to need is you’re going to have to approach a lender when they have time and motivation to get your deal done. In banking, there are certain seasons that are pretty tough. I was an ag banker and spring was hard. Late winter early spring was when we had a lot of renewals. We are gathering a lot of information doing a lot of underwriting of existing customers. And it was really hard to work on relationships for new customers. So there are going to be seasonal cycles for you as a rural business owner, there’s going to be cycles for your banker. Be sure you understand that before you go in demanding very quick service. 

One last thing you should consider when you’re trying to decide on which bank to use this shop around a little bit, it’s going to be easy to spend a little bit of time interviewing multiple financial institutions, multiple loan officers, and seeing who you get on the best with. Who is most willing to listen to your entrepreneurial idea, understand your niche business, and you know the needs that it’s going to have year in and year out. 

Once you’ve selected a bank, you’re going to need to pull some information together in order to be able to make a request and have them be able to underwrite it with the necessary data. First and foremost, they’re going to ask you for proof of income and most of the time, that’s going to come in the form of tax returns. So expect to have your loan officer ask you for at least two to three years of tax returns, sometimes up to five. They’re gonna use this to verify the income that you say that you have. Also examine the trends in your income and expenses in your Schedule F if you’re a foreign business and your schedule C if you’re a non farm business, just kind of understand the trajectory that your business is on. 

They’re gonna want a balance sheet. A balance sheet is just your record of things you own and things you owe. They’re gonna want one probably for the end of the year, if you’re near the 12/31 type of calendar time, or maybe a current one, if you’re midway mid year in the mid summer. The balance sheet is really important to a banker because it’s going to give them a lot of information. First and foremost, your net worth is going to give them some indication of your working capital, your current assets minus your current liabilities, your debt to income ratio as in how much debt do you have supporting how much net worth the available collateral you might have for additional loans. And bankers, of course are going to use this as a menu for sales opportunities, what banking relationships or financial relationships are you already in, that they might be able to give you a sweeter deal on.

They’re going to ask for a projection. Most banks who are in very conventional row crop agriculture in my area will only ask for about a one year type of projection. But if you’re going to be doing something that’s a little more unconventional, they’re probably going to look for a projection that goes a little bit further into the future, maybe three years, some people will go up to five, but anything beyond that everybody’s crystal ball is equally murky. So if you can put together a projection that shows your monthly cash inflows and outflows, predicts any shortfalls you might have and the onset of your business, and helps them to structure the loan so that the payments come due when you have the cash to make them. That’s going to be really informative for your bank’s underwriting. 

Lastly, you’re gonna need a plan, I hesitate to write a business plan because that terminology scares people but some kind of plan either in words or in numbers, or even written down that says what trajectory you’re on the growth opportunity that you’re trying to take advantage of, and the capital needs that you’re going to need to access that growth opportunity. That plan is going to be very essential to be able to communicate effectively to your loan officer, whether that comes as a glossy, 40 page document and a three ring binder, maybe not necessary, but you are going to have to communicate what you’re doing, when, what the risks are, and what your plan is to overcome those risks and provide a successful profitable business outcome. 

You may have heard of the five C’s of credit before.  These five C’s are really just things that you need to kind of have in place and be considering as to whether or not you’re likely to get a yes on the loan request that you make. So first and foremost, we’re going to talk about capacity. A lot of people refer to this one as cash flow. This is basically saying that you have the money available to make payments when those payments are due. Even if there are lean times over the course of the year, maybe you structured your loan so that there aren’t payments due during the lean times and that part of your seasonality. So that capacity, that cash flow provided by your business model and its pathway to profitability, are going to be really important C. 

The second C is capital and or skin in the game. The little picture below shows how the chickens are involved but the pig is committed for a breakfast thing, right? And so the bank wants you to be committed. They want to make sure that you have cash or other equity contributed to a transaction. So it’s not just their money at risk. They want you to be as motivated as anybody else including them, to make sure that you pursue this business proposition as hard as you can and make it successful so that your money is also on the line.

The third C is collateral, the collateral is the security or whatever it is that the bank will collect if you default on your loan. Now, this concept frightens people pretty regularly, and I want to give you some indication that your bank does not want your collateral, your bank wants you to make principal and interest payments on time so that they can use that interest towards their profitability to pay their bills and pay their people. Generally having to take collateral is a lose-lose proposition for both yourself and the bank because you’re losing something of extreme value to your business., and they’re having to liquidate that asset, probably at a below market price, at a really high velocity in order to make themselves whole. So banks don’t want your collateral, generally, they want your interest payments, so keep that in mind. 

Character is the fourth C, some people call it the credit history. And it’s more than just the score that you have on paper. As a matter of fact, when you’re pursuing a commercial loan, your actual credit score might have a lot less influence on the outcome of the transaction, then if you were pursuing a consumer loan, like for a home mortgage, or a car. The other things in your credit history, your repayment history, how often you’ve been laid by how long, what kinds of credit you have, what kind of red flags that you might have in your credit report, all of those things are going to be as important or more so than the actual score. 

Last but not least, conditions. The final C is the thing that you have the least control over unfortunately, if you are in a strange business environment, macro-economic climate, there are certain loans that might seem unfavorable. Think about it, during the COVID pandemic, there probably weren’t a lot of loans made for things like movie theaters, or band venues, you know, where people were getting together. So just be careful that there isn’t sort of an overarching macro-economic situation that’s going to make your loan proposition unpalatable to the financier. 

If you happen to be one of the folks that has a higher risk credit profile, there are certain things that you can do to get to yes, with your banker in order to mitigate some of that risk for the financing organization. First and foremost, some simple things, fix any errors that you might have on your credit report. If you look at your annual credit report, and you see, you know, financial things that weren’t a result of any of your activity, get those fixed by the reporting agencies. 

Secondly, pay down revolving debt, i.e. credit cards, those things are considered current liabilities, and they really have a tendency to reflect negatively upon your current working capital. And so having those kinds of debts be converted into something that’s a little bit more secured, a little bit more good debt, so to speak, rather than bad debt is a good thing. 

Consider alternative loan structures, make sure that you know, even if you’re you know, go in there seeking an annual payment, maybe doing something that’s quarterly or monthly would give that banker a little bit more peace of mind that payments are going to be made on the regular. If you are the type of person where you are comfortable with putting someone else in the mix, you might consider a cosigner or a co borrower, if you are not a strong enough credit risk by yourself, there’s a good chance that somebody else you know might have a stronger credit profile and could enhance your likelihood of getting to yes, just be aware that when their name is on the dotted line that they are just as much at risk as you are and the bank will come for to them for repayment if you are not making yours. 

A third party guarantee can come from an outfit like the farm Services Agency, the Small Business Administration and others, and it’s essentially a promise, and it is a contractual promise that you usually pay a little bit for this says Okay, Mr. or Mrs. Banker, if this borrower defaults on their loan, we will make the bank whole up to a certain percentage threshold of the outstanding principal 75%, 90%, clear up to 95%. So it really takes a lot of risk off the table for the bank. And even if it’s a little bit expensive, getting the yes might make it worthwhile. 

Finally, you could pledge additional collateral if you’re trying to buy a farm, you’re trying to buy a building, you’re trying to buy whatever and the value of that individual piece of collateral, that individual asset is not enough to meet the minimum loan to value requirements for the bank. You might consider pledging something additional. An additional piece of property, additional vehicle, some home equity, whatever it takes in order to get you to Yes. 

If you absolutely can’t get to yes with a traditional financial institution, there’s a lot of alternative financing out there. Why might you consider some of these options? Well, you might have no experience, no collateral, no credit history, basically something that is short enough in your experience base that you’re not yet bankable from that business’s standpoint. You might have a higher risk credit profile, because of your lower net worth, you have unfamiliar collateral, so you’re trying to start an aquaponics business, and maybe a traditional ag banker doesn’t really understand what they can get for fish and gutters and pumps and plumbing systems. If you have a recent bankruptcy in your background, if you have really low liquidity, low cash flow, working capital, all of those things can make you be considered a higher risk. Or you might need gap financing, i.e. you don’t have the 10 or 20, or 30% down that you need in order to get into that transaction with a traditional bank. So these are some of the things that might make you consider alternatives. 

However, I strongly encourage you to proceed with caution. Just because you can get more credit does not mean that you should. A traditional financial institution like a bank or a credit union, Farm Credit, whatever, they’re going to know your complete credit picture, they’re going to have documentation as evidence of your total credit profile, they’re going to have a good idea of what you’re capable of, and what you’re not capable of. And some of the things I’m about to discuss, may not have that full picture. So be really careful. And just so you know, just because one bank turns you down, it doesn’t necessarily mean the next bank will. Different banks have different tricks up their sleeve to get to yes with different kinds of transactions. So if you go to one and you can’t get to yes, and you go to the next bank, you still may be able to do so. 

One of the first questions I get when I’m consulting with entrepreneurs is is there a grant for me to do this? Every so often? The answer is yes. But most of the time, the answer is no. Grants are very specific opportunities that are competitive opportunities for public or private funds that will allow you to do a project that achieves those grantmakers’ objectives, as well as your objectives. They are not commonly used for things like land, equipment, and built infrastructure. It’s more often for working capital for marketing for research and outreach. 

The application can be a heavy lift, and the reporting can be complicated and time constrained with very strict deadlines. So be sure that you can keep on top of those things. And they’re not always completely free. A grant might require matching funds, whether that be cash or in kind. And very regularly nowadays, you have to make the expenditure first, and then apply for reimbursement of those expenditures. So you might have to have some working capital in order to get into your grant project anyway. 

Some examples of grants that might be useful to you: the Value Added Producer Grant from rural development is a large sort of premier grant for farms adding value to farm commodities. It is a $250,000 grant. It is a massive application and very, very difficult and competitive. SARE is the Sustainable Agriculture Research and Education grants, they have grants for farmers and ranchers to do outreach activities. They have grant funds for partnerships between outreach professionals and farmers, there’s a lot of different programs that they’ve got. Also, there’s generally either community or regional grants that are going to be specific to agriculture specific to small business, keep your ear to the ground for those in your local area. 

After we talk about grants, we’re often talking about crowdfunding. This is attractive because it is a very nice investment in your business for very minimal consideration, very minimal, you know, repayment, or gifting or whatever you have to do in order to make your investors whole. Usually, the platform that you’re on, allows you to do that kind of gifting or motivation or incentivizing in order to get around SEC regulations. So it’s not really considered a true investment, but there are limitations also on how you use this. 

You want to use it sparingly. This isn’t a well, you want to go to repeatedly maybe once or twice over the course of your early career, you’re not going to usually pursue really high dollar amounts, unless you’re doing extraordinarily well managed communications and solicitations around your campaign. And you have to be really careful about the terms that each platform uses. There are some that are all or nothing if you don’t meet your funding goal, you don’t get any of those dollars. Whereas other platforms will give you the percentage of whatever you’ve earned. So be certain that you want to use this thing, be certain this is a time that worked well for you, make sure you’re going to be able to manage your communications very carefully and very regularly. Some of the example platforms, the more popular ones include GoFundMe, Indiegogo, and Kickstarter. 

Another type of financing that you very regularly see in farm country is seller financing. This is basically when the owner of an asset acts as the bank, they receive payments over time from the buyer of whatever that asset is. This usually offers pretty flexible terms, very low interest rates, things, other things that are favorable to the buyer, and they can even be guaranteed by the farm services agency in the case of a mortgage from a farm owner to a new landowner. There are limitations on this, of course, there has to be a trust relationship built between the buyer and the seller. The actual technical legal ownership might not transfer until the contract is complete. So if that’s a mortgage, that could be, you know, 20 or 30 years, if it’s just for a tractor or truck or other pieces of equipment, it could be a lot shorter than that. If you default on one of these contracts, that could mean complete loss of equity and return of assets to the owner which neither party really wants. So a common example is family transfers of land or equipment between a parent generation and a child generation on a farm.

Dealer financing is also becoming more common in farm country and in other places where really high dollar pieces of equipment or changing hands. Equipment dealers, input suppliers, co-ops, other types of businesses that are in your business life might be able to finance a purchase of whatever it is that you’re buying from them. They oftentimes have competitive terms, they oftentimes have incentive programs like you know buying your seat at a particular time of year versus another. And most of the time the underwriting is very quick and convenient, oftentimes no more than a credit check. The downside of all of this is that it’s pretty easy to get in over your head because all they’re doing is checking your credit score or some other very cursory kind of overview of your credit history, they might look at you as a very favorable risk when you have a lot of other credit in your profile that might make your service of this debt very difficult. Original Equipment Manufacturers, places like Ag Direct, Sheffield’s, even chemical companies are very, very commonplace to use this kind of financing. 

While we’re talking about big ticket items, there are some things in agriculture and other types of rural businesses that have gotten so expensive, that people who were selling them are trying to find alternative ways to allow buyers to get into these things without traditional loans. One of these ways is Capital Leasing. This is essentially getting yourself into a big ticket asset that’s not through a loan it is through a lease and that lease has payments as a normal operating lease would. But instead of being a normal operating lease, where you give the asset back at the end of the period, you’re actually earning equity towards this item with convertible lease payments, you as the borrower, or the lessee can write off those lease payments as an expense while it’s still under lease. And eventually, once you’ve built up enough equity in that thing, convertible equity in that thing, you can graduate to conventional financing with a typical 20 Year 25% down. 

The limitations of this there is going to be an interest rate that is going to be a higher effective interest. Not every penny you pay is going to convert to equity. The longer payoff period as a reality as well, because if you have a period of leasing for the first five or seven years that you’re in that piece of equipment, and then you graduate into conventional financing, and you’re using a typical term of seven or 10 years or whatever, it might be sort of a long time before you really have full clear ownership of that item. Dealers that we talked about in the last slide. Banks and other non bank financial institutions are working in Capital Leasing, and so it’s becoming a regular part of the financial conversation in farm country. 

I’ve mentioned the FSA and the SBA early in earlier slides as sort of partners in conventional bank financing, but they can be direct lenders themselves. So most of the time the loans are purpose built and mandate driven i.e. the federal government has these agencies the FSA to make loans to farmers, the SBA to make loans to entrepreneurs, they do their best to provide favorable rates and terms. And they often are doing more than just direct lending. They’re tight, they’re doing joint financing with banks, they’re doing guarantee programs, as we mentioned before, so they can be a really, really desirable direct lender and financial partner.

Limitations, there’s not as many people to administer the lending programs as in the traditional finance and banking industry. And they have to be very, very by the book, you have to fit within their box in order to be a good risk and an understandable risk by the folks that are making these loans. Some are more creative than others and will, you know, push boundaries, some won’t. So the SBA and the FSA, USDA’s Rural Development Program all have direct lending programs, joint financing programs and guarantee programs that you might be able to pursue. 

The last alternative financing option I’m going to talk about today is unbanked financing. And I don’t have a better term than unbanked. These are essentially organizations that are acting like traditional financial institutions. But you know, they often don’t have brick and mortar headquarters or they are specifically purpose or values or mission driven. 

So these organizations are doing lending and leasing, oftentimes to sustainable and regenerative agriculture practitioners. They tried to create a pretty high touch relationship, they tried to create unique products with very flexible terms, sometimes low payments on the upfront for new businesses, sometimes no payments. So they get really flexible and really creative in the type of financing that they do. 

Some of the limitations for this is that usually you have to be pursuing organic certification or at least transition and organic certification in order to qualify, they are comparatively young organizations compared to traditional financial institutions and banks, and there tends to be a more limited pool of capital. They have raised X number of dollars, and that’s what they have to lend that year. Some common examples of this are examples that are becoming more common, and include the Iroquois Valley farmland Real Estate Investment Trust, Mad Capital, which used to be Mad Ag, and Dirt Capital out east has now gotten national coverage. All these outfits are willing and able to finance and lend to alternative and regenerative agriculture. 

Just a few take home messages from this slide presentation. For folks who are pursuing financing for their new farm or rural business. Choose your lender wisely, interview a few of them, make sure they have the time, make sure they have the specialty and make sure they have the interest.  When you’re going to that lender to get a loan underwritten, assemble your paperwork that you need to have and be able to articulate a detailed plan about what you’re going to do with those funds. Make it specific: don’t ask for an arbitrary number of dollars. Make sure that there is a clear request based on needs for accessing an opportunity. 

If you are not quite there, as far as bankability, consider credit enhancements, consider loan guarantees, consider loan structure changes, consider other things that can make your loan work better for you. And of course, as we mentioned, in the second half of this presentation, banks aren’t the only option. There are plenty of alternative financing opportunities aside from banks in order to get financing for your organization. But be careful not to get in over your head. 

If you’re looking for more information on developing a rural food or farm business, please do drop by the Extension Farm Management page. In addition to all the financial tools and templates, you can click on the business development link and peruse a section on beginning farming and enterprise development. Or swing by Edible Alpha which is where the Food Finance Institute keeps its archives of articles, podcasts and webinars on a whole slew of Food and Ag Entrepreneurship topics. Once again, I want to thank you for joining us for this rural entrepreneurship video series. I’m Andy Larsen with the Food Finance Institute at the University of Wisconsin System. I look forward to seeing you again soon.