Hog Production Management

[Mustang Sally Farm]

Production Management Featured Articles


Evaluating the Contract Finishing Opportunity - Part 1. Is Contract Swine Production Good for You?
Wednesday, April 03, 2013





Contract swine production can be an attractive opportunity to the right individual, family or operation if it fits with the person, the farm and financial situation. Chrisian Boessen of the University of Missouri explains the pros and cons of contract growing for producers.

Increasing numbers of farmers, aspiring farmers and rural landowners are considering a contract hog finishing enterprise as a way to enter agriculture or expand or diversify their current operation.
 
This publication is in response to questions and issues related to this decision and is intended to help with the decision process. Every person, opportunity and situation is different in one way or the other, and the following discussion is more about helping you ask the right questions than giving generalized answers. Even for farmers with substantial operations the decision to enter contract production is one of the biggest decisions they will ever make. It involves a set of decisions related to farm business strategy, investment analysis and personal/family issues. Like any business venture, it is best to go in with 'both eyes open' in order to be satisfied in the long run. The best possible situation for contracting firms and growers is that expectations and reality are in line over the life of the contract and beyond.

What is Contract Finishing?

Contract finishing is an enterprise where two or more parties share the risks, rewards and responsibilities of producing market hogs. For this discussion, the author refers to the two parties as the 'grower' and the 'contractor'. The grower typically makes the investment in buildings and a site, maintains the facilities and provides labor and management associated with caring for the animals, manure hauling and certain record-keeping functions. The contractor typically provides all the inventory items such as animals, feed ingredients as well as technical support, vet services and transportation of pigs to and from producer buildings. The contractor usually specifies a recording keeping system and may provide that as a part of the overall arrangement.

A primary reason that contract production works is that it allows the contractor and grower(s) as a team to spread risk while achieving a higher level of per hog profit because of scale and specialisation. By working together a contractor and grower(s) can create a 'bigger pie' than either might be able (capital and labour) or willing (risk) to create on their own. It is an shared risk enterprise between the grower and contractor where both bring resources to the table, each is shouldering some of the risk, and each is sharing in the overall returns.

Nationwide, approximately 47 per cent of all hogs produced are finished under production contracts. In 2003, the University of Missouri surveyed contract growers nationwide and found that a large majority of growers and contractors were fairly well satisfied with the arrangement and 80 per cent of growers planned to continue with their current contractor.

Why Choose Contract Production?

A major reason why many consider contract finishing is that it tends to fit well into the resource base of the typical farmer/land owner and often offers an income opportunity with more quantifiable risks. The financial returns of most farming enterprises come with significant production, price and financial risks. With contract swine production, price risk is typically eliminated and depending on the arrangement, production risk is primarily assumed by the contractor. Increasingly in the Midwest, contract payment is made on a flat annual dollar amount for each pig space in the building, regardless if the contractor utilises the space. However, contracts offering payment based on a per-pig delivered out of the building have been common in the past and are still prevalent in certain areas.

For farmers with crop-land, the second major incentive to consider contract production is the nutrient value of the manure. This benefit can have significant impact on the cost-side of the overall farming operation in the seemingly permanent environment of high fertiliser prices. A 2012 study by the University of Missouri Commercial Agriculture Program estimated that a 4,000 head grow-finish operation on a 1,000 acre corn-soybean rotation would annually generate nutrients valued at almost $60,000 net of spreading costs based on $0.62 per pound (lb) of nitrogen (N), $0.53 per lb phosphate (P2O5 and $0.50 per lb potassium (K2O).

Relative to non-contract swine production, the amount of capital required can be substantially less under contract production. The primary difference is that little or no operating capital is need by the contract grower. Consequently a balance sheet which is not able to support the full amount of borrowing necessary to engage in farrow-to-finish production may very well support contract production. Contract finishing is also generally considered to be lower risk by lenders and thus the debt capital may be easier to obtain.

Many small- to medium-sized farrow-to-finish operators that are at a crossroads with their operations are moving into contract finishing. Many of these farmers are at a stage where they know investment in farrow-to-finish facilities commits them to dealing with the work of farrowing for a longer period than they desire, given their stage in life. Given modern production technology such as automatic sorting, contract finishing is a way to utilize resources while creating work they can envision doing for a longer period of time.

Contract finishing also can provide a means for new producers, especially young people, to enter swine production and establish their first farm business. Many of the young farmers who got their start contracting in the 1990s have their first buildings paid for and are expanding their farms with additional free cash-flow.

Often there is excess labour on the farm and contract finishing may provide an opportunity to utilise labour and generate income for that labour when few other alternatives exist in the local community. The additional cash flow from the contract operation can help smooth the up and down income from cropping productions or other activities.

The Market for Growers

Contract growers and prospective growers should think in terms of a 'market for growers'. Like any market situation, there is supply and demand. In any given area, there is a demand for growers and a supply of growers. How strong demand is depends several factors such as the presence of contractor operations including sow farms and/or slaughter facilities. Everything else equal, factors that will enhance the demand for growers include access to relatively cheap corn and soybean meal, the presence of feed milling infrastructure, good roads, and not too many people.
 
The demand for growers will also tend to be stronger in areas that have established numbers of contract growers. This sounds obvious but the point is that unless a contractor is up against some other constraint, the contractor will be willing to pay more to establish a grower relationship that is near the other growers as acquiring another grower relationship nearby may lower the average cost of doing business with all the other growers.

The supply of growers in any given area will be largely fixed in the near term and determined by factors such as the number of landowners and farmers in the area, demographics including age and wealth of farmers/land owners, availability of capital, environmental regulations and opportunities for other employment in the area. The supply of contract growers seems to be greater in areas where there is a history of contract production.

For the individual considering a contract finishing enterprise, the take-away of this analogy is that almost everything is easier and the returns may be higher and more stable if you are operating in an area of strong demand for contract growers. In general, it will be easier to start a contract enterprise, have a successful contractual relationship and should you choose to, sell your operation in an area of strong demand for contract production. For example, in an area where there are multiple contractors working with growers, lenders are more comfortable with the long-term prospects for the business, will know more about the business and will be more willing to lend money for contract startups. Operating costs can be lower in areas where there is substantial contract production. For example, in areas of significant production there are more likely to be custom manure applicators and custom building-cleaning crews, which can eliminate equipment costs and reduce labour requirements. Conversely, as you move away from the areas of strong demand, you may have a harder time getting started, receive less for your pig spaces, incur higher costs and face faster depreciation of asset values.

Is Contract Finishing Right for Your Situation?

For producers that have existing facilities that are moving to contract finishing, the primary questions are most likely related to specific contract terms and contract negotiations. If you are starting from scratch and have read this far, it probably means you recognise the potential advantages, but know there is a great deal of analysis left to do in order to make an informed decision about a contract enterprise.

The first thing that should make it clear that this is a big decision is the size of the investment. Unless you have been involved in confinement livestock production, the investment may seem shockingly large. Expect to spend $200 to $250 per pig space to build facilities in addition to development of the building site (roads, grading, electric, water supply etc.). Most contractors seeking new growers expect the grower to build at least 2,000 to 2,400 spaces. Like many investments in farming, this one is a single-purpose asset.
 
Again, like many other investments on the farm, it is illiquid - which is a fancy way of saying it will be really expensive to change your mind. The contract is a long term commitment. The whole endeavour could not be more unlike the 'old days' of getting in the hog business by stringing woven wire on the hillside, sticking a couple thousand dollars in some A-frame huts etc.
 
Before you can decide if it is the right move for you, there are four key issues that you can sort through relatively quickly before you get bogged down in details of contract and investment analysis: know yourself, know your farm, know your financial condition and know the contractor.

[Mustang Sally Farm]

1) Know yourself

The first hurdle you have to get over is making sure you are personally comfortable with a contract relationship. A certain level of trust is critical in the contract relationship, as the contractor will be in control of many factors that affect the returns to and value of your investment. It is very important for you to understand how much managerial control you will have in a contract arrangement. Most management decisions will be made by the contractor.

The contractor will expect you to follow very specific instructions within the contractor's system for producing pigs. You may or may not agree with inputs being used or practices prescribed, especially if you have your own ideas or if you have raised pigs before. Many growers consider this a positive aspect of contract finishing as they have plenty of other things to worry about, and not making a lot of decisions on the contract enterprise is one less headache. Visit with other growers that work with the prospective contractor, not only to learn how they feel about the contractor but about what they are expected to do and not do under their arrangement. You simply do not want to get into a situation where you disagree or second-guess your contractor as it will only cause problems down the road.

Other issues that warrant considerations are generational transfer and retirement. In some ways, a contract finishing operation can work well with the next generation coming on the farm and many farmers retiring from farrow-to-finish operations do contract finishing. With retirement and or generational transfer, it is important to draw out a time-line of loan payments and retirement or transfer horizon so all parties understand the arrangement. This especially true if there will be a buy-out and/or financing. As with any business investment, you should consider your 'exit strategy', which involves answering the question: How can I get my investment back out of this facility?
 
A confinement hog building is not an easy asset to sell, particularly if manure spreading acres are an issue. If you think you may want to sell out of the investment in the future, it is best to plan for that from the start. For example, consider building the facility on land you would be willing to sell. Make sure the sale of the parcel would not disrupt the rest of the farming business.

At this point, you might say: "I wouldn't mind XYZ if the financial returns are adequate." If that is the case, you should circle back to this question after you have done the cash-flow analysis described in the Pig Information Gateway publication 'Evaluating the Contract Finishing Opportunity Part 2: Key Factors in Evaluating a Production Agreement'.

2. Know your farm

Some farming operations are a great match for contract finishing while others are not. Before you get too far into the analysis of a contract finishing opportunity or evaluating alternatives, be sure that a confinement enterprise fits into your situation. The primary considerations relate to the site, the neighbourhood and environmental issues and labour availability. Topography and local infrastructure are also fundamental requirements. Contractors generally require that sites can be accessed by tractor-trailer rigs for feed delivery and market hog shipping.

Making sure the enterprise fits the neighbourhood is an issue that all parties should be concerned about. How close are the nearest neighbours? What is happening in terms of residential development? The facility type under consideration and manure management practice associated with it affect the neighbourhood issues. Environmental concerns primarily relate to how you will store and apply manure and how odors may affect nearby landowners. Some farms have situations such as karst topography where groundwater is easily harmed or land uses that do not utilise nutrients well may be difficult to manage.
 
Farms where there is a row crop operation typically have few problems with manure management and are generally in a good position to capture the value of manure. Farms with little open land and/or land utilization that does not involve crop removal will find manure management more of a challenge. Your Regional Extension Specialist and personnel at the USDA Natural Resource Conservation Service can help you understand the suitability of your farm for a contract finishing enterprise.

3. Know your financial condition

Before you get too far into the details of a contract opportunity, consider your capability to borrow several hundred thousand dollars. You may or may not know the overall implications for your balance sheet and what additional leverage might mean for you and your farm. This question is more of a 'back of the envelope' analysis. Different lenders have different criteria for lending to contract operations and it is best to speak with a lender with a track record of financing contract finishing.

Lenders with experience in this sector of the market will have very good knowledge of the capital necessary and the debt-servicing ability of the assets. You will need a up-to-date balance sheet and recent income tax returns. Visiting with a lender with experience in financing contract finishing operations has a number of benefits. The experienced lender can help, early in your decision making process and can help you avoid problems their other customers may have encountered. At worst, the lender might see early on that the enterprise is not feasible for your situation, which may save you considerable time, expense and perhaps even heartbreak.

4. Know the contractor

Ideally, if you are considering contract finishing, there is more than one contractor actively seeking growers in your region. But in any case, a crucial aspect of any business decision is knowing the party with whom you are about to do business. This is especially true when there is a long term agreement involved. You must make an assessment of the contracting entity and perhaps the parent company which is offering a contract to you. It may be a large agribusiness firm or a family member or another independent family farm within the region. The following discussion sets out a few questions you should at least ask yourself, and preferably the prospective contractor.

First of all, it is very important to know something about the contractor's financial position. If there is no way to get a feeling for financial strength of the contractor (e.g. privately held firms or individuals), it will be difficult for you to get comfort as to the risk of the arrangement. You are concerned that the contractor will be there five years from now, placing pigs in your building so you may retire the associated debt and achieve other financial goals.
 
Given that the contractor typically assumes all the price risk, could the entity survive a storm like the industry saw in the late 1990s? If your lender does not have an opinion on the strength of the contractor in question, seek out a lender with the resources to have done the due diligence on contractors active in the region. If a lender says their institution is not financing facilities associated with a particular contractor, the message should be clear.

Another set of factors that you must consider relate to the long-term strategy of the contractor. The most basic question is their commitment to a contracting strategy. Is it apparent that the contractor is specialising in other facets of hog production and has a significant dependence on contract growers for the firm's success? You would not want to be in a situation where another farmer or entity is contracting the finishing stage in order to cope with a short term situation. A regional commitment is also important. As a general rule, you do not want to be 'outside' of the region where the contractor is already established, unless you know there is a significant commitment to a new region. Groups of growers make for much more economical and profitable relationships for the contractor. Growers off by themselves are more expensive to support and to service with baby pigs, feed and hauling of market hogs.

The best source of information about any contractor is other growers. Ask several other growers about their relationship with the contractor. Historically, has the contractor been good in their commitments to others? Do other growers feel their relationship with the contractor has evolved in a positive fashion? Have there ever been operational 'changes' that involved an aggressive contract interpretation or a situation not anticipated under the original agreement? Information on past performance is typically the most valuable, and sometimes the easiest information you can obtain when evaluating a contractor.

Learn what you can about the contractor's swine production system. Visit with Extension Specialists or other knowledgeable individuals familiar with the contractor's operation. Are they using good genetics for the region? Where do they get their feed? Do they have a health programme to ensure that you will receive healthy pigs? Does their building design make sense for your region in terms of manure management, ventilation, winds and snow loads? Make sure the building that the contractor requires is an 'industry standard' size. Few contractors want a building that takes another half load of pigs to fill. Learn about the contractors system relative large competitors. If the contractor you are considering is doing something very different, it may be a great opportunity but it could also mean that you are an 'odd ball' in terms of finishing operations. Remember that you want to be 'in demand' as a grower for the long-haul.

If you are new to swine production, you will be especially interested in understanding what if any services or programmes the contractor offers in terms of grower support. Contractors that invest in their growers, in terms of educational programmes and management assistance demonstrate a long term view of their business relationship.

Summary

Contract swine production can be an attractive opportunity to the right individual, family or operation if it 'fits' with the person, the farm and financial situation. This is especially true for those operations that can fully utilise the nutrient benefits of the manure.
 
But it is extremely important to go into the arrangement well-informed and with confidence in the counter-party to the grower-contractor relationship.
 
For readers choosing to further explore contract swine production, there is a follow-up to this publication entitled 'Evaluating the Contract Finishing Opportunity Part 2: Key Factors in Evaluating a Production Agreement' which is available on the Pig Information Gateway.

April 2013

[Mustang Sally Farm]

Evaluating the Contract Finishing Opportunity - Part 2. Key Factors in Evaluating a Production Agreement
Wednesday, April 10, 2013





Chrisian Boessen of the University of Missouri offers tips to evaluate the economic and legal aspects of the agreement that establishes a relationship between grower and contractor.
 
This publication is a follow-up to the Pig Information Gateway publication 'Evaluating the Contract Finishing Opportunity Part 1 - Is Contract Swine Production Right for You?', which mainly examines non-economic issues related to the decision to grow hogs under production contract.
 
This article is intended to assist with actually evaluating economic and legal aspects of the document that establishes a relationship with a contractor.

Contract finishing is an enterprise where two or more parties share the risks, rewards and responsibilities of producing market hogs. For this discussion, the author refers to the two parties as the 'grower' and the 'contractor'. The grower typically makes the investment in buildings and a site, maintains the facilities and provides labour and management associated with caring for the animals, manure hauling and certain record-keeping functions. The contractor typically provides all the inventory items such as animals, feed ingredients as well as technical support, vet services and transportation of pigs to and from producer buildings. The contractor usually specifies a recording-keeping system and may provide that as a part of the overall arrangement.

Practically speaking, a prospective grower has two broad concerns when evaluating a contract. Usually, the grower wants to understand the economics or profit potential of the arrangement. If the economics make sense, the prospective grower must then delve into and understand the 'fine print', which typically make up the bulk of a contract and these sections and clauses govern the relationship between the grower and contractor.

Cash Flow
 
Understanding the cash flows - both income and expenses associated with any contract finishing opportunity - is the number one priority in the decision-making process. Projecting cash flows will help avoid financial problems that could arise from periods of negative cash flow.
 
Also, it is very useful to do your own cash flow budgeting and not to rely solely on the individual cash flow sample budgets provided by the contractor. Contractor-supplied projections may represent ideal conditions or average conditions. For example, a quarterly cash flow projection might show positive cash flow in all quarters but in reality, there could be one or two months in the quarters where there is not sufficient cash available to pay bills.
 
Inflows of cash may be based on a fixed dollar amount per pig space per year or as a payment for pigs delivered from the facility. Cash outflow in a normal operating year will be associated with expenses such as maintenance, utilities, taxes, manure management and hired labor. The difference between the inflows and outflows associated with operating the contract finishing enterprise is called net cash flow and represents the return to the grower's investment of land, labour and capital. Getting a good idea of the average annual net cash flow will help you compare the contract enterprise to other investments and uses of your time/labour.
 
It is also important to take the cash flow projection another step and ask "What if...?" This exercise is called sensitivity analysis and is done by 'shocking' expense categories if analysing a payment per pig space contract. With a payment per pig shipped contract, the sensitivity of the revenue side should be examined by reducing the assumed/average level of animal performance or changing other variables to see how cash-flow holds up under less than optimal conditions.
 
Think about what expenses could fluctuate significantly, for example utility expense due to extreme cold and/or rising LP gas prices. If you do not remember, ask your local LP supplier how high gas prices have been in the last 10 years. Also, some expenses will simply increase with inflation. Evaluate the implications of cash expense items increasing two or three per cent per year over the life of the contract. Be aware that contracts rarely provide for inflation or cost spikes.

If the estimated net cash-flow from operating the contract enterprise seems acceptable, it is imperative that you understand the cash out-flows associated with the start-up period. The start-up period includes the first expenses associated with the facility such as engineering or consulting and site preparation. There will be several months of severely negative cash-flow during construction. It is also important to know when the first cash in-flows will occur relative to the completion of the facilities.

Ask the contractor about any 'lumpy' or unusual cash flows that will likely occur over the life of the contract. This could include lagoon pump-downs, lagoon cover replacement or equipment replacement (feeders, waterers, gates, fans). It is also imperative that the long term cash-flow adequately covers maintenance, repairs and ordinary equipment replacement. You do not want to get to the end of a contract with worn-out equipment and a facility that has not been maintained. In that situation, you will be negotiating from a weak position and are unlikely to attract the interest of other contractors.

Another major cash-flow issue is related to debt service requirements. You need to know how much of your net cash-flow is going to be required each year to cover principal and interest. It is usually best if the contract payments and loan payments match over the course of the year. Monthly contract and loan payments are ideal for matching cash-flows and will minimise interest expenses. Quarterly payments are more common and the next best alternative. As for loan maturity, most lenders require that building financing is repaid in seven to 10 years. Attempting to repay the loan in a shorter period may leave little cash flow for family living expenses.

The consequences of not being able to pay principal and interest on time mean that it is imperative to evaluate possible scenarios where cash in-flow could fall short or be delayed. When the contract payment is based on pigs spaces provided, this is basically evaluating the contractor's financial strength. When the contract is based on head shipped, payment could fluctuate for a number of reasons. Pigs can die or the contractor may not place pigs to capacity in a timely fashion. If the contractor can cause cash in-flow to fluctuate, the grower should expect some minimum guaranteed cash flow that is related to the principal and interest payments.

Finally, understand the income tax cash flows over the life of the contract. The trap to avoid, especially if the contracting arrangement is a primary source of income, is the 'phantom income' situation. Phantom income refers to the situation when your depreciation deduction runs out and even though your gross income does not change, the income and self-employment tax bill related to the enterprise spikes dramatically. This situation can be devastating if the facility loan is amortized over a period longer than the period used for the depreciation method. When the depreciation runs out, cash available for debt service can drop significantly.
 
Visit with a tax professional and go over the cash flow projections to avoid or plan for the phantom income stage in the life of a contract production enterprise.

[Mustang Sally Farm]

Understanding the Contract
 
Once you are have evaluated the feasibility of a contract enterprise on your farm and you are comfortable with the prospect of a relationship with the contractor, you should invest the time and money needed to closely evaluate and understand the contract. This means having a legal, written contract that you fully understand. Have an attorney review the contract and have that attorney advise you on every provision before you sign it. You will also want to seek financial and tax advice to help evaluate whole farm business financial implications and tax management strategies.

The first big issue is understanding what type of facilities the contract requires and exactly how they get built. Ask the contractor if their firm helps in arranging bids and can assist in buying materials to obtain the best possible pricing. Know if the contractor has a list of building firms that can bid on your facilities. Talk with other growers about their experience with the construction process.

Evaluate the specified building design and ask a local engineer familiar with swine finishing buildings to look over the plans. Is the design appropriate for winds and snow loads in your area? Are the buildings of a standard design that might work for multiple contractors? You want a facility that will appeal to other contractors in order to assure there is demand for your enterprise down the road.
 
You should also consider future expansion. Often contractors specify building capacities just below that requiring concentrated animal feeding permits and engineer certification. If your initial finishing enterprise is sized below permitting requirements, the building design may not be certified by a licensed engineer. If you decide to build a second building in the future which would likely put you in a permitting situation, you may face a regulatory requirement that the structures have engineering certification.
 
At a minimum, make sure any manure storage structures, such as pits, lagoons or slurry storage are certified by an engineer. Getting certification on an existing building can be expensive at best and at worst impossible if the contractor employs a poorly designed building.

Contract maturity is an important consideration. Is the contract duration at least as long as your real estate loan on the facility? To minimise any difficulties in obtaining financing, know exactly what the contract payments will be over the life of the loan. Conversely, make sure you are working with a lender that can make a loan that does not mature before the loan is paid off. Avoid loans requiring a 'balloon payment' at maturity unless there are other significant sources of liquidity. You do not want to have to 're-qualify' for the loan in five years.
 
Sometimes contracts are of shorter maturity or renew whenever a new group of hogs are moved into the facility. Shorter contracts will typically pay higher returns as the risk is higher to the grower and lower to the contractor. If you are in a situation where you can assume more risk, for example if you are moving existing, paid off buildings into a contract relationship, higher returns might be possible.

Be sure to understand how and when payment will be determined and remitted. If it is a per-pig-space payment, know when it will be paid. Will you receive scheduled (e.g. quarterly) payments or will it hinge on when the pigs are finished and they are completely loaded out of the building or will you received payment at some intermediate point before the pigs are completely finished? This will be especially important in terms of timing of cash-flows, specifically to time receipts when loan payments are due.

If the contract is not based on a per-pig-space payment, are there any guarantees in the contract? You tend to see more of this type of language in contracts that make payments on some variable factor such as pigs placed or pigs shipped or on pounds of gain. Contracts that pay based on the number of animals placed in the building will often guarantee 70 to 80 per cent of capacity per turn. These types of minimums are often designed around the principal and interest payments on the buildings. If the contractor has the option of not filling the building, know the guaranteed minimum you will receive if anything. Understand that in a minimum stocking situation returns to labour, management and your capital may be zero or negative. It will typically be difficult to obtain a high level of debt financing without corresponding minimum payment clause.
 
Regardless of financing, as a grower, you are accepting significantly more risk relative to a guaranteed per pig space contract and should expect higher annual returns.

Understand if there are any incentives clauses in the contract. Many contracts which pay per animal placed/shipped, also have incentives to encourage you to do the best possible job. These incentives are often based on achieving minimum death losses, or levels of average daily gain or feed efficiency. Another frequent incentive item is based on minimising sort loss to ensure you ship out a uniform truck-load of market animals. Realise that efficiency related incentives are largely determined by the quality of feed and the genetics of the pigs. Visit with other growers to determine if incentives will result in a meaningful expected increase in returns above a base payment.

Know if the contract is for feeder pig-to-finish or wean-to-finish pigs. If a contractor brings you feeder pigs (40-50 pounds) to stock your wean-to-finish barn, that would typically mean less work for you. If you have a feeder-to-finishing barn and the contractor has the option of bringing you weaner pigs (just weaned) then the nature of the contract could change dramatically, particularly in terms of labour and utilities.
 
Contracts also often contain a clause that requires the grower to invest in equipment or technology in the future in order to keep the building up to certain standard required by the contractor. While typically related to feeders, waterers or sorting equipment, such a provision may also be used in combination with a strategic shift from feeder pig to weaner pig finishing. Similarly, if you are not interested in raising breeding animals, which typically end up larger and harder on facilities, be sure your contract precludes that use of the facility. If the contract does not specify the size of pigs coming in or going out, be sure you have thought through what might emerge, and make sure you are comfortable with those possibilities.

The contract will invariably say that the grower is responsible for managing manure and following environmental regulation. Be sure you understand what this entails. Know what equipment you will need to buy to deal with manure or be aware of custom rates for pumping, hauling and application. Do you have enough land? Can you spread on a neighbour's land and will you always be able to do so? The same situation applies to mortalities (dead pigs). Know the regulations and methods that are allowable and what each costs for the size of operation under consideration.

Default provisions are often the most surprising and/or troubling to prospective growers. What are your obligations under default and what constitutes default? What is likely to happen or could happen to the building? A default is typically related to poor performance or actions that endanger the animals. In these instances, the contractor reserves the right to occupy and manage the building, typically suspending some or all payments to the grower.
 
These clauses are unsettling but when you consider that the contractor owns the animals, it is not unreasonable for the contractor to create a mechanism to protect the animals. Often, lenders will require similar clauses in financing terms that allow them to take over the building in a delinquency situation.
 
Conversely, you should understand what happens if the contractor defaults. Do you have any special rights within the contract to choose another party to continue to use the building? Be sure your attorney explains the implications of any clauses related to dispute resolution.

Understand if there will be any assignment of contract proceeds? This is often done when there is significant financing. Proceeds refers to the contract payments, which under assignment, go directly to the lender with any left over proceeds after payment of principal and interest returned to you.

If the contract payment is based on animals placed/shipped and/or if substantial incentives are based on animal performance or death loss, you need to know if you can reject poor animals at delivery and if you can replace them with high-quality replacements. If you reject an animal, will your building be allowed to run partially empty, and that animal will not be replaced?
 
Also, know who is responsible for providing each input and for taking care of environmental concerns, for instance, dead animal disposal, which normally falls to the grower.

What are the Alternatives?
 
When a grower chooses to enter into a contract arrangement he/she is making a commitment of both capital and labour. Once committed, the hours needed to care for the animals and maintain buildings cannot be 'sold' to another enterprise or employer. Likewise the money invested - whether debt or equity -
 
will be extremely difficult to get back out of this enterprise to invest elsewhere, on or off the farm. Prospective growers should consider their investment alternatives to the swine facility to assure that you are most satisfied with your investment and relationship with a contractor in the future. Investment alternatives include other contract opportunities, other farm related investments and off-farm investments. Similarly, if the prospective grower is actually going to supply their personal labour, consider the 'wage' the enterprise is paying for your labour and management. If the contracting enterprise is part of a larger farming operation that can capture the value of the manure, be sure to consider this cost-saving in the returns.

A final and important note about comparing returns to a contract enterprise. Breaking the cash flows down is a start but making proper comparisons is still tricky for a number of reasons. One of the biggest issues when comparing alternatives is that many contract growers attach a non-monetary value to being able to create 'paying work' on the farm, to not having to spend time commuting, doing a type of work they prefer or allowing a family member to stay on the farm. These non-monetary returns are real but can make comparisons difficult.
 
A second issue is comparing returns on investments that are of different risks. The risk associated with a given contract finishing arrangement will be hard to quantify, as there are many forces involved. But make a conscious effort to consider return and risk before accepting or rejecting a major investment—think about how you will sleep with one investment versus the other.
 
Contract finishing returns may be lower than other possible investments on the farm but without much of the risk that many traditional enterprises carry.

Summary
 
This discussion has covered many of the most important considerations in evaluating a contract finishing arrangement. A prospective grower must thoroughly understand the expected net cash-flows of contract arrangements and risks associated with the cash-flows.
 
The contract will typically spell out the type of facilities built and how they will be operated and managed.
 
Every situation is different and you should thoroughly evaluate the opportunity, both the good and the bad.
 
An investment in a contract finishing enterprise can be a profitable long-term venture and a win-win arrangement for everyone involved, but it is best if a grower enters the arrangement, totally informed, having thoroughly analysed the financial, cash-flow and legal implications and risk of each potential contractual arrangement.

If you are offered a contract opportunity and would like professional help, contact your local extension office. Your extension profession in farm management, animal sciences and agricultural engineering will be glad to assist you as you work through your decision. A financial/tax advisor may be advisable to totally understand the projected cash-flows and anticipate changes that will occur over the life of the arrangement. Also, do not think twice about hiring an attorney to review the contract, it is imperative that you fully understand all aspects of the contract.

[Saharuth]

New knowledge is very good. I like to read these stories because it is a story that is not far from us.