5 Ways To Balance Debt During Your Operation's Transition
How do you manage equipment debt, transition and an economic downturn? Time does not slow down, and transition and change happen whether we are ready for them or not. There are five key areas to focus on in this scenario.
1. Know your debt repayment capacity.
Many operations with higher equipment debt have a good base of owned land and lower land costs. This can create highly profitable crop production but makes equipment debt a glaring black eye. Understand your budget projections, cash flow needs and ability to repay short-term debt.
2. Have a capital expenditure plan in place.
You know what doesn’t help equipment debt? More debt. If you don’t have a clear plan for debt repayment and your future purchases, you might have a delay in transition or longer repayment with lower profitability.
Map each piece of equipment and your plan for trades or upgrades either in the next five years or through transition.
3. You can’t gift debt.
But you can change the name of the lessee on most notes within family operations. Moving from a single owner to multi-owner entity the initial borrower is a member of is also possible and fairly common. Consider a structure that fits the senior generation’s tax implications and the junior generation’s ability to take on liabilities and equipment replacement.
4. Be prepared for depreciation.
In 2015, we saw massive depreciation on equipment following a softening market and plunging prices.
Consider how this will affect your net equity, asset valuation, replacement plan and expectations for the next generation valuing and buying equipment.
5. Understand your net equity position.
Net equity is simply assets minus liabilities. An operation with $2 million in equipment and $500,000 in debt has a net equity position of $1.5 million. This is the amount everyone involved should understand for transition, growth, equipment rates and debt repayment.
Here are a few additional considerations for your operation’s transition:
- Valuations are going to change rapidly at some point. Be realistic. Market valuation shouldn’t be what’s on auction sites. It should be what the machine is actually worth and what someone will write a check for. It should also be an agreement between transitioning parties based on appraisals.
- Don’t ask the next generation to buy equipment for more than it’s worth. If you love iron, take a supplement by mouth once daily. Don’t treat the next generation unfairly just because you think it’s worth more.
- Equipment isn’t a retirement strategy. It’s becoming a small piece of the puzzle. Values are high, depreciation is like a wrecking ball and production is catching up. Operators get their feelings hurt when they get valuations back. You can be happy or you can be informed, but not always both. Know the numbers and their implications on your business.
