FIMCLA - Discussion on Agricultural Co-Operative Development Issues

Co-operatives have been a major contributor to the agricultural sector in Canada and they show continued promise in the changing economy, especially in view of changes in market concentration. Co-operatives, however, have unique financing issues, both in securing debt and equity capital, and struggles with capitalization are limiting co-operatives' success in the agricultural sector. Improved access to debt-financing, equity capital and technical advisory services are prerequisites to ensuring strong co-operative development and growth.

While FIMCLA can help address debt-financing needs, other critical needs of co-operatives require attention. In addition to the current consultations for improvements to FIMCLA, co-op stakeholders' input will be valuable to AAFC as it looks at options for a more comprehensive approach to supporting co-operatives.

In preparation for the afternoon session on co-operatives, the following questions are presented for your consideration. You will also find attached a background note that presents an analysis of the situation of agricultural co-operatives, based on recent studies, reports and internal analysis.

Questions for Consideration

A. Opportunities for Development

B. Challenges to Development

C. Challenges and Opportunities for Capital-Intensive, Value-Added Co-operatives

Value-added ventures require significant capital and specialized skills in key areas such as marketing, technology and management. This can present some additional challenges.

D. Opportunities and Challenges for Rural Communities

Agricultural Co-operatives - Background Note

Policy Context

Co-operatives are an important contributor to Canadian agriculture, generating over $19 billion per year in revenue and employing approximately 36,000 people. They return $150 to $200 million worth of surplus to farming communities each year.

Co-operatives are increasingly attracting attention for an expanded role they could play in agriculture, gaining notice from within and outside the federal government. At present, current Federal-Provincial-Territorial agricultural policy, specifically the Agricultural Policy Framework (APF) recognizes the importance of co-operatives to the sector as business risk management and renewal tools.

A report prepared by the Minister's Advisory Committee on Co-operatives (2002) outlined how co-operatives can engage farmers to successfully compete in the new economic environment. This includes:

The report concludes that co-operatives can assist farmers to improve their competitive position and income, as well as contribute to innovation and renewal in the sector.

However, in Canada, agricultural co-operatives have had growing difficulties with capitalization as a result of the high levels of capital required to compete in a globally competitive environment, especially in capital intensive value-added processing. This is demonstrated by the number of co-operatives in the grain, dairy and poultry industries that have demutualized. As well, though the BSE crisis brought an increased interest in co-operatives, many of the newly initiated co-operatives have remained in the feasibility stages because of capitalization difficulties.

In this context, recent federal government reports recommend increased support for agricultural co-operatives. These include the Easter Report (2005); the Senate Report on Value-Added Agriculture (2004); the House of Commons Committee Agricultural Report (2002); and a report delivered by the House of Commons Standing Committee on Finance (2004). The reports advocate comprehensive support for co-operatives and highlight their potential in the area of value-added, mentioning New Generation Co-operatives (NGCs)¹ in particular.

Several of the reports call for government to examine and adopt loan guarantees, tax incentives and other measures to facilitate the capitalization of co-operatives. The Standing Committee on Finance, for example, recommended that the government create a co-operative investment plan and undertake a review of tax and non-tax measures that would help the sector meet its capitalization needs.

The Canadian Federation of Agriculture (CFA) and co-operative organizations have also called for increased capitalization support for co-operatives, to put them at the centre of a strategy for the long-term growth and stability of the agricultural sector.

Credit Supply and Needs Analysis

Overview of Financing Issues for Agricultural Co-operatives

Co-operatives have unique challenges securing both equity and debt capital, largely due to their unique ownership, voting and governance structures.

Equity Capital
The limitations of agricultural co-operatives' traditional sources of equity, i.e. members and surplus, are more pronounced in the current economy. As the capital requirements for start-up and expansion are very high, it is increasingly difficult for co-operatives to rely solely on members to meet their equity investment requirements. Farm consolidation and unfavorable commodity markets also limit individual producers' ability to contribute equity. Start-up co‑operatives do not have the option of retaining patronage dividends since they have not yet generated a surplus, while mature co-operatives may be in the position of having to replace the equity capital of retiring members in order to maintain their capital base. Mature co-operatives have the ability to retain patronage dividends, but since these will eventually be returned to members, lenders may not view this as equity.

While attracting external investment is a new option allowed in some jurisdictions in Canada, co‑operatives may have difficulty attracting substantial numbers of investors because they offer limited scope for return on investment. Raising external capital through the sale of shares can also potentially create tensions between the need to serve members and the need to satisfy investors.

Debt-Financing
Co-operatives, especially start-ups, rely more heavily on debt-financing than do other enterprises due to their equity constraints. Securing debt-capital can be more difficult for co-operatives for the same reasons. A study on co-operative capitalization issues in Canada found that lenders may also lack familiarity with co-operative business practices and may perceive them as being more risky than proprietorship or other businesses due to low equity levels and perceived management issues (Ernst and Young, 2002). This can result in loan refusals or more stringent loan conditions.

Overview of Credit Needs

Need for Capital
Recent studies on the capitalization needs of agricultural co-operatives concur that capitalization is a major challenge for some agricultural co-operatives in Canada. The challenge is greatest for small and start-up co-operatives (Fulton 2001; Farm Business Consultants (FBC), 2005), as well as for those attempting expansion (Ernst and Young, 2002; FBC, 2005).

Capitalization issues are having an adverse effect on the growth of co-operatives and on their representation in the agricultural sector. The problem is such that co-operative representation is declining in certain agricultural industries because of inability to obtain capital. In some jurisdictions where legislative change has been made to enable co-operatives to seek outside investments and to facilitate the creation of NGCs, there has been little growth². This is attributed to a lack of equity capital among members and an inability to attract debt-financing (Ernst and Young, 2002). Interviewees approached by Ernst and Young also expressed concern that under-capitalization is limiting co-operatives' ability to react quickly to changing market conditions.

Need for Support and Technical Advisory Services
The capitalization challenges of co-operatives go beyond simple availability of capital. Perceptions of risk and potential low performance also affect access to debt-capital. As such, the studies on capitalization for co-operatives highlight non-financial support as an important aspect of capitalization. Fulton (2001) found that start-up producer groups have trouble accessing financing partly because they lack time, proposal writing capacity and familiarity with program mandates to access it successfully. Farm Business Consultants identified a need for improved levels of support in the areas of business planning and for access to co-operative expertise. Stakeholders shared similar views.

The case of Québec points to the role of non-financial support in mitigating negative perceived or actual financial risk and management capacity. While most stakeholders consulted view co‑operatives as higher risk (FBC, 2005), this was not the case for Quebec's government lending
Agency, Investissement Québec. Investissement Québec views co-operatives as being no riskier than other businesses, linking this to the support infrastructure that exists for co-operatives in Québec. In fact, their co-operative loan portfolio actually performs better than that of other businesses.

Canadian and international comparisons suggest that integrated support is a significant factor in the growth and development of co-operatives overall. Ernst and Young (2002) found that in Australia limited government support, lack of specialized lenders and minimal support amongst co-operatives has slowed their growth. Their research showed that limited government financial and non-financial support has also restricted new co‑operative development in Canada. In contrast, the province of Québec has comprehensive support for co-operatives and is responsible for over half of new incorporations in all sectors in Canada in the last 12 years (Co-operatives Secretariat Annual Survey of Co-ops Data). In the U.S, the financial and development assistance provided to producer groups has also been a determining factor in the growth of NGCs (Fulton, 2001).

In recognition that the role of support plays in the development of co-operatives, recent studies have called for increased support for co-operatives Canada-wide. Among stakeholders, there is a belief that business advisors and other professionals have limited knowledge of the co-operative model, and that their expertise must be expanded in order to provide co-operative advisory services to the sector. Similarly, a Canadian Adaptation and Rural Development (CARD) funded study by the Canadian Co-operative Association and the Conseil Canadien de la Coopération (2001), set governance and leadership training and expanding the capacity for co‑operative development as priorities.

Existing Assistance Programs for Co-operatives

Federal and Provincial Programs
Co-operatives are eligible to participate in a number of agricultural programs at the federal and provincial levels. Most programs provide modest financial assistance for business planning and management activities, and do not directly capitalize co-operatives. The FIMCLA and the Manitoba Government's loan guarantee and co‑operatives share programs are the only programs in Canada which specifically target the debt-capital needs of agricultural co-operatives. Investissement Québec also has a loan guarantee program that targets co-operatives regardless of sector.

Programs Provided by Lending Institutions
Lenders consulted reported different levels of involvement with co-operatives. Several have no lending programs for co-operatives and/or little business with them, however, some felt that there is an opportunity there. A few have products tailored to co-operatives, while others evaluate co-operatives in the same way as commercial clients or individuals. Credit Unions are playing an increasing role in lending to the co-operative sector, and they believe that there is a role for the FIMCLA in financing innovative ventures and acquisitions that are less easily financed through traditional lending.

Early Consultation Findings

Discussions with stakeholders also provided insight into the low participation of co-operatives in the FIMCLA program. Stakeholders felt that there is a need for some type of loan guarantee program for co-operatives, but that FIMCLA could be more effective with modifications. In particular they requested that the administrative burden be lessened and that the eligibility requirements of the program be relaxed in several ways (Table 1). They suggested that the registration fee is too high and the interest rate too low given the program's poor reputation for paying out claims. They also asked that the program be better promoted and stressed that technical assistance is an important aspect of supporting co-operatives' access to financing.

Source: Farm Improvement and Marketing Co-operatives Act and Industry Consultation

Canadian Agricultural Co-operative Trends

An analysis of key trends in Canadian agricultural co-operatives suggests that, while co‑operatives continue to be a popular form of incorporation for farmers, they have not been able to capture growth potential in value-added activities.

Recent Evolution in New Co-operative Incorporations and Revenues

The number of new incorporations of agricultural co-operatives indicates continued interest in the co-operative model among farmers. Table 2 shows that approximately 30 to 55 agricultural co-operatives have been incorporated each year in Canada between 1993 and 2004. Of these, approximately one third to one half were marketing co‑operatives, and a significant number were feeder finance co-operatives.

Feeder finance co-operatives have been developed to help address the cash flow needs of livestock farmers, by facilitating their access to preferential terms of credit that would assist them to purchase stock. Development of feeder finance co-ops has been made possible by provincial loan guarantee programs for producers. We have excluded them from further analysis since they were created as intermediaries to facilitate financing, and do not have the same financing challenges as most co-operatives.

Table 2 – New Incorporations of Agricultural Co-operatives for 1993-2004

Source: Co-operatives Secretariat Annual Survey of Co-operatives

Despite growth in new incorporations, co-operatives have not performed financially as well as firms in the food processing sector. Table 3 shows that while the food processing sector has experienced a steady increase in revenues, co-operatives have experienced slower growth since the mid 1990's. Beginning in 1999, revenue levels accelerated in the food processing sector but declined for agricultural co-operatives. This decline is attributed to a few of the large marketing co-operatives that demutualized during this time, and hence no longer report as co-operatives. If we remove the influence of these changes, the overall revenue trend of co-operatives has showed steady or small growth which has not kept pace with the upward revenue trend in the food processing sector.

Source: Co-operative Secretariat Annual Statistical Survey and CANSIM Table 301-0003 – Annual Survey of manufacturers (ASM), principal statistics by North American Industry Classification System (NAICS), incorporated businesses with employees having sales of manufactured goods greater than or equal to $30,000.

Financial Position

Ratio analysis can be used to monitor the financial strength of any type of business, including co‑operatives. The debt to equity ratio is the most commonly used leverage ratio, and gives an indication of the degree of operating freedom a co-operative enjoys. Higher ratios can signal debt pressures which can cause a firm to forgo profitable growth opportunities. The debt to asset ratio shows the proportion of assets that are financed through debt. Higher debt to asset ratios indicate a higher proportion of assets financed through debt, and increased vulnerability to creditors.

Ratio analysis of agricultural co-operatives in Canada shows that they have low overall equity levels (Table 4). Agricultural co-operatives created in the last 10 years have yearly average debt to equity ratios of 1.34 to 2.13, demonstrating the extent of their reliance on debt. While yearly average debt to equity ratios are somewhat lower for agricultural co-operatives as a whole (1.50 to 1.80), they remain much higher than in the food processing sector (0.8 to 0.9). The debt to asset ratios also suggest that co-operatives carry a high level of debt compared to the food sector.

This suggests that agricultural co-operatives, particularly agricultural marketing co-operatives, rely more on debt capital to leverage investments than does the agri-food sector as a whole. This is not only the case for recently established co-operatives but also for agricultural co-operatives in general. This supports the argument that co-operatives have more difficulty in obtaining equity capital and that they rely more on debt-financing than other agri-business organizations, in turn limiting their ability to take advantage of investment opportunities.

Source: Co-operatives Secretariat Annual Statistical Survey
* Data represents the range of the yearly average ratios for the co-op groupings
** Excluding feeder finance Co-ops.

Conclusions

Co-operatives have been a major contributor to the agricultural sector in Canada and they show continued promise in the changing economy, especially in view of changes in market concentration. However, co-operatives have unique financing issues, both in securing debt and equity capital, and struggles with capitalization are limiting co‑operativess success in the agricultural sector. Improved access to debt-financing, equity capital and technical advisory services are prerequisites to ensuring strong co-operative development and growth.

Bibliography

Ernst and Young. Canadian Agricultural Co-operatives, Capitalization Issues and Challenges: Strategies for the Future. November 2002

Farm Business Consultants (FBC). Assessment of Needs and Issues Related to Financing of Agricultural Co-operatives. March 2005

Fulton, Murray. New Generation Co-operative Development in Canada. Centre for the Study of Co-operatives. Saskatchewan, 2001.

Fulton, Murray and Daniel Coté. Canadian Agricultural Co-operatives: Critical Success Factors in the 21st Century. 2000.

New Generation Co-operatives Pilot Project. Centre for the Study of Co-operatives. 2001.

Canadian Adaptation and Rural Development Fund, Co-operative Sector Initiative, Performance Report 2000-2001, AAFC.

The Co-operative Option: A Natural Fit for Public Policy in Agriculture, Minister's Advisory Committee on Co-operatives, May 23, 2002

Future Role of Government in Agriculture. House of Commons Agricultural Committee. 2002.

1 New Generation Co-operatives (NGCs) have unique features which differentiate them from traditional co‑operatives. They are typically organized for marketing and value-added activities, which tend to be capital‑intensive. In an NGC, members make a significant up-front investment proportionate to their anticipated use of the co-operative, which is formalized in delivery rights. A binding agreement between each member and the co‑op sets out delivery rights and obligations in relation to equity invested.

2 Co-operatives, including but not limited to NGCs, have the ability to allow external investments through investment shares that have restricted voting rights in the co-operative.