January 7, 2009

Economic efficiency is paramount to profitability in crop production operations. Machinery and production equipment costs represent a major cost factor and one that has been on the rise in recent years. The National Agricultural Statistics Service reports that machinery and equipment expenses and fuel expenses have increased by 11% and 14% respectively from 2006 to 2007. Proper management of these costs represents a key area where producers can effectively and efficiently recapture gross margin.

One means for managing these costs is equipment sharing, while another is the use of machinery leases (see Leasing or Owning Farm Machinery — What's Right for You). Machinery agreements can be structured in many ways; however, the most common include: 

1. Sole ownership with a custom agreement - one party owns the machine, makes all payments including repairs, and makes an agreement with another producer for the use of the equipment, similar to renting equipment
2. Joint ownership - each party in the agreement is responsible for a portion of all payments, including principle, interest, and cash expenditures

Advantages of Shared Machinery

There a number of advantages to sharing machinery costs, including: 

• Shared expense of high cost agricultural machinery
• Efficient use of the machinery — equipment may be used over more acres annually than may have been possible in a single operation
• Opportunity for shared labor, mechanical skills, and repair facilities
• Possible increased purchasing power in equipment selection due to combined financial resources
• Opportunity for new and beginning farmers with fewer resources to partner with established producers to effectively manage risk exposure

Disadvantages of Shared Machinery

There are some disadvantages to joint ownership as well. They include:

• Bottlenecks in production — both owners need equipment at the same time
• Cash flow needs of one owner may not coincide with the needs of another
• Machinery down time may be detrimental to both owners, depending on field demand
• Potential for death, bankruptcy, or unplanned retirement of one owner
• Payment deficiency by one party requires another owner to pay more to keep equipment
• Independence in ownership is lost - decisions on machine disposal must be agreed to by all parties
• One owner may be harder on machinery than another, or returns equipment dirty, or in disrepair

Starting the Joint-Ownership Process

Communication between all potential owners in a joint machinery venture is critical to success. There are a series of steps which must be completed:

1. Both parties must agree on the size and capability of the intended machine. If the shared item is too small, efficiency is lost to production bottlenecks and the higher potential for breakdowns.
2. Decisions must be made on brands, fuel types, and machine characteristics. This is an important step when considering the various creature comforts and technologies available on today's agricultural machinery.
3. The machinery agreement must be completed.

The Machinery Agreement

This is the most critical aspect of shared ownership. This document determines the management of the machine/item, including how it is to be used. Following are just a few of the questions that must be answered when preparing the agreement. 

• What determines who uses the equipment and at what time?
• Is there a maximum number of acres or hours for each owner's use?
• When controversy occurs regarding use priority, whom, or by what standard shall the final decision be made?
• How will repair/fuel/lube costs be separated?
• How will the machine or item be transported from one location to another?
• What are the investment requirements of each party involved?
• Will one party make the payment on behalf of the others or will each party make a separate payment?
• How will use or availability of the equipment be determined?
• What happens in the event of a bankruptcy, an unfavorable court ruling, retirement of an owner, or the untimely death of an operator?

Failure to address these questions in the written agreement may be disastrous. Do not assume that because you are entering into a relationship with a family member or a very good friend that a shared machinery agreement is not needed. Remember that agreements are designed to support and build business relationships, not tear them down.

The Investment Process

Several methods can be used to determine the investment requirements of each party. This guide will demonstrate the equitable distributions method. As you become more experienced in joint ownership agreements, or as a particular situation dictates, you may devise alternative ways to determine each party's investment in the joint agreement. The method shown here serves only as a template to demonstrate the principles behind the financial discovery process.

We will assume that two operators have decided to enter into a shared machinery agreement to buy a new tractor. Farmer A farms 800 acres of corn and soybeans; Farmer B farms 1000 acres of corn and soybeans. When determining initial investments, each party decides to separate costs based on acres farmed.

The cost of the new tractor is $165,000 and neither party is offering a trade-in. In this example, Farmer A would be responsible for 44.5% of the initial cost, or $73,425; Farmer B would be responsible for the remaining 55.5% or $91,575. The parties agree through contract that the loan will be consolidated through the dealer at 6.5% interest. The final payment (principle and interest) on the loan will be $14,974.81 (biannual payments over 10 years). Farmer A is responsible for $6,663.79 and Farmer B is responsible for $8,311.01 per payment period.

Both parties agree to run a fuel and repairs account for the production year, running from January 1 to December 31. At the end of this period, expenses are recorded.

Table 1 illustrates how Farmer A and Farmer B accumulate $25,400 dollars in annual operating expenses, $11,100 and $14,300 respectively. Based on their agreement, Farmer A pays 44.5% of the respective gross annual operating expenses, and Farmer B pays the remainder. If these expenses had been made during the year and not on account, we would conclude that Farmer B has overpaid $203 for his share of the expenses, and thus Farmer A would pay Farmer B $203. This list of annual payments also could have included insurance costs, housing costs, licensing fees, legal fees, equipment transportation, etc. The overall concept is the equitable separation of costs based on some agreed logic.

Four Examples of Joint Ownership

Examples of annual financial records for four joint-ownership scenarios have been developed to illustrate how expenses might be divided in a given year. They are based on the number of acres in operation, but could easily be converted to other units of measure, such as engine hours or fuel used. The scenarios for these examples are similar to those above in that Farmer A farms 800 acres and Farmer B farms 1,000 acres. In all the examples Farmer A and Farmer B decide to jointly own a new tractor.

Example 1: Farmer A and Farmer B decide to jointly own a new tractor. (See Example 1)

Example 2: Farmer A has agreed to pay for the fuel/lube and maintenance on the machine and Farmer B has agreed to carry the insurance and the housing costs. This example represents a situation in which one operator has access to superior housing or better insurance rates that may benefit both partners in the long-run. (See Example 2)

Example 3: Farmer B has agreed to pay for all operating expenses and to rent out the machine to Farmer A on a per acre basis, based on costs. Farmer A has limited cash flow, while Farmer B is more solvent. Farmer A agrees to pay for 50% of the fixed cost, and thus to accept 50% ownership in the equipment, and to rent the equipment on a set per acre basis for those acres used during the year. The rental payment is designed to pay for the variable costs accessed during the year. (See Example 3)

Example 4: Farmer B has agreed to pay for all costs and to rent out the machine to Farmer A on a per acre basis, based on all costs. Farmer B pays all costs, including the overall purchase. This example is only loosely a joint ownership agreement, as Farmer A does not acquire any ownership rights to the equipment. At the end of the year, Farmer B determines all costs, and the overall cost of annual ownership based on acres worked by both parties. Farmer A pays Farmer B for the total acres worked and the calculated per acre annual operator charge. (See Example 4)

Depreciation

Both parties separate and accumulate depreciable values based on their agreement. This method is similar to the crop share agreements used by many producers. For simplicity in some joint-machinery agreements, operators agree to return or replace equipment with a full tank of fuel. This would negate the need for a joint fuel expense account and would further simplify the accounting process.

Managing Unforeseen Partner Changes

Generally, should a partner need to leave an agreement for one reason or another (bankruptcy, retirement, or death), the first option to buy the equipment is given to the remaining operator(s). If this option is not exercised, then the equipment is sold to the highest bidder and any remaining proceeds are divided. If the remaining operator(s) decides to exercise the option to purchase, the price may be based on the current appraised market value or some other agreed upon depreciation scheduling.

With a joint machinery purchase, the respective titling as tenants-in-common would offer undivided interest in the asset. If an operator would die, the interest in the equipment would pass on to the remaining party in the agreement. Other options include joint tenancy, which would allow for ownership of the asset to pass to the remaining partner(s) in the event of death. This type of agreement works well for heirs, parent/child, and sibling arrangements. When completing the purchase agreement, it is important to specify the type of business relationship you want.

Other unforeseen events, such as irreconcilable differences, may occur as well. It may be that through all your best efforts, a disagreement cannot be resolved. It is important that you include a dissolution plan in your partnership agreement. This plan outlines the steps necessary to dispose of the asset in an equitable manner, per the agreement of both parties. For example, two operators have a written agreement to share a tractor. The agreement specifies that should the first operator wish to dissolve the agreement, he or she would notify the second operator in writing at least 30 days in advance. The second operator, by written agreement, may have the option of buying the first operator's remaining share, based on an appraised value. If the second operator chooses not to buy out the first operator, the equipment could be sold on the open market to the highest bidder and the remaining loan balances paid off. Any proceeds from the sale would be split by the parties involved.

Summary

Joint ownership of agricultural equipment offers an opportunity to spread costs over multiple entities. Overall acquisition and annual maintenance costs are applied to an operation based on mutual agreement. This enables an entity the opportunity to capture both depreciation and operating expenses on the equipment, while lowering total cash outlays. Joint ownership also allows for larger equipment purchases, which may be required, depending on the net total acreage of the combined operations.

Joint ownership of equipment requires both a written agreement and good communication to be effective. All parties must realize that they are partners in the investment. It's important that the equipment agreement be structured such that it addresses the issues and concerns identified in this guide and any others that may occur between all involved.

Tim Lemmons
Extension Educator