Equity capital and how to leverage it

Shay: Welcome back everyone to another episode of the Ag View Pitch. Today you have Shay Foulk with Ben Gordon again on Fractal Ag, and I think we're gonna call this one, uh, Fractal Ag Round 2. So hopefully you're ready for round 2 here, Ben.

Ben

Gordon: Excited for it, Shea. Good to be on.

Shay: Yeah, happy to have you back. And kind of what we wanted to do was reintroduce the concept to what Fractal Ag is about and more so follow up with what Chris and I are seeing in the marketplace as far as decisions and some of the key things that we think producers are going to face in the next 4 to 5 years related to and surrounded by capital and just what options are out there. So the farm operations that are listening to the Ag View Pitch or the 19 Minutes progressive farm operations looking at the long-term visionary outlook for their business and trying to decide how do we make good decisions moving forward How do we capitalize in economic downturns and really set the, set the precedence and kind of set the rocket ship launch pad, if you will, for the years ahead?

Ben, I think maybe what I'd have you do here is give your, you know, couple-minute overview of FractalAg, just history and kind of what the last couple of years has looked like as the business has progressed. And then I'll dive into some specific questions.

Ben

Gordon: Sounds great. So yeah, Fractal Agriculture, we are a farmland capital— or sorry, a farm capital provider. And what we do is we provide farmers with equity capital. So we're not providing debt, not competing with the bank. That's equity capital by investing in land that farmers operate today. We do minority investments, and then farmers are able to kind of take those investments that we make in the land that they own to then go, you know, take that capital to go make other improvements or investments on that farm, whether it's more land, other kind of capital improvements, whether it's drain tile, on-farm storage, or just shoring up their balance sheet because maybe it was a little bit tight. And, you know, our core customer is exactly what you described.

It's the farm that's looking to farm not just next year, but next decade or well beyond that, whether it's them, their families, or their business partners. And really our whole model of of kind of farmland investing and providing capital to farmers is based on a couple of really simple but core concepts. One, the farmer's in control, they're the majority owner, and they have full economic control. We just think that results in better stewardship of that field or that farm asset. Number two, we want to align incentives. So we win when farmers win. So, you know, our cost of capital and our returns are higher when, frankly, farmers are doing better, there's more appreciation in the farm that they own, and they have more equity capital. And then, you know, if land goes down, or things go south, we go go south with them. So we're on that same side of the table.

And then the last thing is, you know, just trying to share risk, you know, wherever, wherever it makes sense. And, you know, one of the biggest areas there is, you know, where farmers are using practices that build soil health, we give them discounts on kind of the annual cost of capital that they have. In other words, just, it's cheaper, you don't pay as much in that annual payment if you're doing things like no-till, strip-till, cover crops, integration of livestock, where that makes sense on your, on your operation.

Shay: So some people listen to that and they said, okay, equity capital, Ben, equity capital can be expensive. We've, you know, heard some horror stories on that. But the first thing, and I would say is probably number one on the list for the reason, is having farmers in control and being the ones to make decisions. So how does this, how does this differ from other sorts of investments or some of your traditional lending outlook? Why, why did Fractal Agriculture feel that this was a space that could help everyone in the ag community? Not just Fractal Agriculture, but also the farm operations? And why is having the farmer in control so important?

Ben

Gordon: Yeah, I mean, most of our team comes from farm or rural community backgrounds. But frankly, we just think it's a better selfish bet for an investor to put farmers in the driver's seat. You know, farmland has 1 to 2% institutional ownership, I think it'll be a heck of a lot higher than that.. But the reason that, that it's only at that level is not because investors don't want to invest in farmland. It's that it's really hard to get that local knowledge and local management of that asset. And to us, it just seemed glaringly obvious that the answer is right in front of us. That's the farmer. And, you know, call me old-fashioned, but I think incentives and self-interest, you know, usually kind of guide the way for a lot of human beings.

And so for us, you know, if we could find a way to solve what was just a very clear farmer need for equity capital, given that, you know, we have great lenders in ag, but they'll only go kind of 40 to 60% loan-to-value. Like, the math just says you need equity capital, especially with consolidation and kind of how expensive farming has gotten to be on both the kind of the input side and the equipment side, not to mention land. It just makes a lot of sense if you want to make more money investing in farmland to support an operator who's going to get the most out of it. And, you know, in return, we have to give a very clear and transparent current product to a farmer. So we lock an investor in for 10 years. There's no— the farmer can exit at any point after 2 years. They have full kind of exit liquidity control, not the farmer.

So that's one way that, you know, that farmers are kind of locked in. They have operational kind of agronomic control. We're not going to tell a farmer how to farm. We might incentivize certain practices, but that's a carrot, not a stick. And we think by partnering with really solid financial and agronomic operators, that will result in better management of assets, that will result better returns for our investors. And if it just so happens to strengthen rural communities and keep a decentralized kind of farmer-led agricultural system, then I'm pretty darn happy with my personal values of how I grew up.

Shay: Yeah, that's awesome. There's a book I recently listened to called Not a Good Day to Die. And it talks about trusting the guy on the ground. And just having that inherent trust that, you know, the ones that are operating the farm, operating the land, and the farm business managers and operators that are listening to this are the people that know the land, love the land, care for the land, and they're going to do right. And so when you look at how that is appreciating over time, and what the long-term incentive is for, you know, fractal agriculture to be involved in that as they look to grow their business, there's dividends that pay out on both sides there. There's a good show called The Office, Michael Scott, fictional character, has a part in it. He says, okay, explain it to me like I'm 6 years old, and then he didn't understand it.

So he said, okay, now explain it to me like I'm 5. What I would like you to do is to give maybe a simple example of how fractal agriculture is working or would have a goal to work with farm operations so that listeners can have an idea of, you know, in their minds, how might this look in my farm operation? How might it make sense to partner with someone like this in the ag space?

Ben

Gordon: Got it. So, I mean, it starts with, with the need. And so, you know, we're typically working with an operation that, you know, has good strong cash flows. It's not— this isn't capital of last resort. And so, you know, let's say you have an opportunity to buy out a landlord, pick up a new piece of ground, or, you know, add, add some needed grain storage that'll really help your overall operation. But you want to keep enough of a buffer because you want to bulletproof your balance sheet, as kind of you and Chris described in kind of your end of year podcast. And you know that if you go do this deal, deal, it might stretch you a little bit and now is not a good time to be stretched. So you have a need for equity capital. That's when you go, you reach out to Fractal or you think there could be a need down the road.

So what you're going to do is we're going to engage, we're going to just talk through what the transaction will look like. And at its simplest, we're going to find a field that is a good Fractal investment. It doesn't have too much debt on it. It has good strong yields, good productivity, or at least good strong yields versus what you would expect. It's going to be a really simple transaction. We're going to agree on a valuation. We'll present to you and show, show you how we got to our valuation. And once we agree there, you know, we're going to buy a minority portion, less than 45% of your field. You're going to take the proceeds from that sale to go do what you need to go do on that farm and make that investment. Every year you're going to pay an annual payment. It's going to be somewhere between 4.5% and 5.1% of that, that asset value.

And you're going to pay that payment once a year. And then you're good for the year. You're going to have some end-of-year reporting just financially and a little bit on agronomics. It's nothing crazy like a carbon program or something like that. That you already have. And then at the end of 10 years, you know, we're— we have our share that, that we own and we will get a third-party appraisal altogether and you'll either buy us out at that point for our share or hopefully we've earned the right from you and our investors to go do another transaction and we open up another 10-year instrument that buys out the first one. And we're good to keep partnering on that asset.

Shay: Yeah, that's a really good version. 5-year-old me understands that, so I appreciate that. One thing that I think is interesting that you said in there and that I want to highlight is whether you have the need now or whether you think that you'll have the need down the road. So the process that Fractal Agriculture goes through is, you know, just getting that evaluation done, trying to find the right piece of property, having the conversation, making sure everybody feels comfortable as part of that transaction. Can you maybe talk through a little bit more on why it's important to make that connection and how that capital is being deployed, how you guys think about that from an investor standpoint? Maybe just elaborate on that a little bit more.

Ben

Gordon: Yeah. So, I mean, I think the really important thing, like you mentioned, is like that need and where it fits. And then, you know, for us, it's all about where we try to be transparent with what feels going to be the best deal. And then, you know, so that way you're ready when the time comes. More often than not, that time is coming sooner rather than later because folks, when they're going and having their conversations with their banker this time of year or they're doing capital planning, they want to show and have a stronger balance sheet. And so we might, you know, we'll go and we'll underwrite a field and we might do a smaller transaction first. So that way we're ready for a bigger transaction down the road. You know, we're pretty darn flexible as Fractal. Like, you're not going to get a hard sell from us because that's not the right answer.

There's, you know, using us is not always the right answer, often in isn't. Oftentimes, there's other options, and we want you to use those other options. So I guess at its simplest, what I'd say is, you know, look at your long-term plan, look at your short-term plan. If there's a need for either, go, go out, reach out to our team, fractal.ag. That's A-G without my North Dakotan accent. And, you know, look at if the overall opportunity could be a fit, and then go get a field underwritten, see what capital options you have.

And then have some good tough conversations amongst your farm team, with your farm advisors, with your banker about, you know, where you really are going, and how much buffer and growth you really want to have, especially in times like, like today, where there's a lot of opportunity on the horizon, because not everyone's going to be prepared, whether you're using Fractal or not.

Shay: Yeah. One thing that you said there was, you know, those opportunities typically come at you faster than you think. And what I would say to that is, The speed of change doesn't care whether you're ready or not. And the number of people that we've seen capitalize on opportunities that took time to diligently prepare for them or anticipated change of some sort, whether they knew it was a specific instance or not, are the ones that have had rapid growth in the last 4 or 5 years or over the last 10 years in those periods of economic downturn.

And I would just highlight 2014 to 2019, there's a lot of rough years in there from the commodity agriculture standpoint, but a lot of people that were able to take advantage of opportunities and double down, whether that was growing the business or adding infrastructure or adding people or taking on these opportunities that, again, that speed of change, it doesn't matter whether you're ready or not, it's coming at you. And that's why I think your message is so important there. I want to, I want to shift gears just a little bit. And, and the reason that we're having this conversation is, one, I really like what you guys are doing with Fractal Agriculture. But you and I talked, you know, this is not— this isn't a pitch for Fractal Agriculture.

This is understanding the tools that are available outside of, you know, your traditional lending, working with investors, working with family partners, and, and other people and other methods of sourcing. But I want to highlight And I'd pick your brain on this a little bit, Ben, of why, you know, what you guys are seeing and why it's so important right now to have this equity capital in the agriculture environment and how the farmers that you're interacting with are thinking about ways to utilize what you guys are doing.

Ben

Gordon: Yeah, I'd say it really starts with, you know, where prices and expected cash flows are going are frankly making some folks nervous. And there's two groups that I call out. And, you know, one is the ag lenders at an institutional and individual level, they're tightening up a little bit, even though total loan volume is up, because I don't think balance sheets are quite as strong as we expected. And the second group are older farmers or landlords that don't necessarily have a transition. And I think the big so what from the combination of those two things is that there's going to be less capital available and more, more transitions that could really accelerate kind of land turnover, asset turnover. And consolidation.

And so what that means in terms of what we're seeing is even really well-capitalized farmers are seeing some of that working capital or that kind of buffer on their balance sheet evaporate because they have a landlord or a farming partner who says, hey, I'm ready to hang it up. And, you know, I, you know, I'm now not ready for the next deal that might come out, even though I thought I was in great shape 6 or 12 months ago. And so, you know, that speed of change that you mentioned, we are seeing that today. And so getting ahead of things, having not just the long-range planning for, you know, if everything goes perfectly, but, you know, the worst-case scenario, kind of back to our shared military experience, you know, what's the most likely course of action? What's the most dangerous or unexpected course of action? And, you know, having the flexibility for that.

The other thing that I would say that, you know, seeing especially from, I'd say, some of our more forward-thinking folks is engaging with their stakeholders and their farm team. I've heard several operations just in the last 2 weeks who are engaging with their landlords, especially really early, not going out and asking for rent reductions or anything like that because we don't know what the, what the year is going to have, but just communicating transparently and especially communicating about, hey, their flexibility to support that stakeholder's transition, whether that's a future crop share, a future lease, future purchase, and flexibility in that. And just being really creative to say, are there ways that, you know, 1 1 can equal more than 2 by being ready, by being planful, by being empathetic, and just a good steward of your local community.

And that's a lot easier to do when you have a strong balance sheet and a strong operation, and you're, you're kind of from a position of stability, not from a position of scarcity in your own operation, in your own mindset.

Shay: So this method and, and structure and model, you know, I prompted you beforehand, I haven't really had time to think through this question myself, but Are there other industries out there that are using this that would be a comparable look to those who are in agriculture and in farming that maybe haven't been exposed to something like this? Like, where else is this being used and deployed and implemented outside of agriculture?

Ben

Gordon: You know, there's kind of two levels to the question. I think the first one is the one that I actually was kind of the genesis of some of Fractal, which is find me another commodity industry that is capital intensive where we ask the main operators of that industry to grow without equity financing. And you won't find one. Like, you look at all the big mining companies, the fertilizer companies, when they have to grow capacity, there's always equity financing along with, along with debt. And the fact that that doesn't exist in a productized, transparent, kind of clear fashion in agriculture, to me, is a failure of the market and something we're trying to remedy. So I think, you know, if you look at just even standard real estate transactions for an office building, another highly stable for the most part, I guess, maybe not recently asset.

You know, you typically will find equity financing to go out alongside, you know, you yourself as a developer to go do a deal, to go build something. And so this idea of equity financing is not an original one. Like, we're ripping it off of just common practice for over 100 years in a lot of industries where that goes. You know, the unique uniqueness is we're doing, you know, kind of this minority version of it. And, you know, this model comes from the home equity space and expensive markets like San Francisco or New York where getting a down payment is really hard. And several companies have kind of come in with, with products that allow you to get equity exposure. You give them some of the upside, you share that. So you're able to actually go in and own the asset that you have. And so we get really excited because, you know, those models did a lot of the regulatory work for us.

But we think the model fits farmland a heck of a lot better, just because the need is so much greater. And there's so much precedent in other industries for just, you know, why this makes sense from a financial sense for both that underlying operator and outside capital.

Shay: So then the person is saying, okay, if it hasn't been done in the last 100 years in agriculture, you know, if something stinks, there might be something funny going on. Why is that? So Maybe the harder question here is, okay, why hasn't someone done this in this space? And why does— why is Fractal Agriculture different?

Ben

Gordon: I was really naive. And I was like, it's really dumb that equity financing doesn't exist. And we should put it alongside farmers, because that just makes sense. That was well over 2 years ago, when I started the company. And what I've learned is, it's a ton of work, and you need a really diverse set of skills. To go do that. And, you know, this wasn't my master plan. I kind of stumbled into a group of people when we were working at Granular and Corteva and several other jobs where we have a set of people who know finance, who know the legal side, who know the technology to be able to go underwrite these deals. And most importantly, having a group of people that come from some rural or farm background and truly just— this isn't the most eloquent way to say it, but have the give a shit test. In spades for the overall mission and for the customer, because this is not easy.

This is going to be a very tough slog for us for another 6 to 18 months through kind of the big proof phase. But even the traction we have to date and what we're hearing from farmers and what we're seeing from investors, there's demand for this asset. And our performance, because we're aligned with really good operators, means that there is a ton of capital out there. And, you know, frankly, I think, you know, humans tend to shy away from big gnarly complex problems with diverse skill sets unless they're really damn passionate about what they're doing. And that happens to be us.

Shay: One thing that I've realized here over the last couple of years is when you're facing a problem and you start to get frustrated by it or it's, it's challenging, I kind of had to reshape my mindset on there. And basically it's like, well, yeah, I mean, my job is to solve problems. Like that's what I get paid to do is to solve problems and to address them.. And I think that's where if a lot of farmers and a lot of people in agriculture kind of shifted that mindset to attack and tackle the problem versus just, you know, kind of suffer and wade through it, that they would realize the opportunity, you know, target-rich environment out there to go take advantage of some of these things like equity capital and what you guys are doing. The follow-up question that I had here is in relation to the appreciation and value.

So some areas have seen massive appreciation and value, some areas are pretty steady. So I'm going to pin you down to a number. Just that I know it's hard, but what's, what's a number that you guys kind of use when you think about it from an appreciation standpoint in that land?

Ben

Gordon: You know, I guess when I look on a, you know, it's a 10-year instrument. And so that makes my answer a heck of a lot easier, because the range of outcomes over 10 years is pretty narrow if you look at US farmland broadly. Obviously, there are exceptions, and like, you know, your local market better than we do. But, you know, if you look at average, average farmland appreciation in institutional markets, so those tend to be higher appreciating than the USDA. So I'm gonna use a bit more aggressive number, because I want farmers to think through a more extreme case that ends up being about 5.73%. If you look over the last, you know, 30, 30-odd years, and the high is closer to about 7, 7.5, and the low is is closer to about 4.5. So like, that's not that big of a swing. Because usually that 10 years has 1, 2, maybe even 3 commodity cycles in it.

And they tend to kind of wash each other out a little bit. But it's usually kind of an up and to the right. And if you look at a wide enough lens, like it looks like a straight line, but on the year to year, there's a lot more variability. So at the end of the day, I guess when I look at it, both from a farm seat and investor seat, it depends, are you trying to make a quick buck and speculate there? I would have to give you— I'd have to do a lot more work. And I'm not good enough to predict markets. And that's not the business I'm in. I believe in the long-term supply demand of farmland. And like, that data is pretty darn clear on the direction that things are going. The total magnitude, I don't know. But, you know, if history is a guide, and I look at just like where history will change, it only looks to be steepening from my perspective.

But, you know, that's just one guy from North Dakota who's now sitting out in San Francisco. So you have a few screws loose if you just think about that combination.

Shay: Yeah, I get it. With the, you know, with that outlook on 5.73% is what you said. I actually, my wife and I just got back from a loan renewal meeting and we're fresh off of TPAP down at Texas A&M. So a lot of really high-level business-oriented thinking. You know, when I was at the bank, I asked the question, where are money markets at? What else does the bank have to offer? And the bank actually had a trust option for any excess cash that is a 5.73% 0.25% return right now. So when I think about the deployed capital, whether you need it now or not, or like we've referred to it in the past, I think on the first episode, it's just having dry gunpowder ready to go so that when the opportunity strikes, you're ready, you can pull the trigger.

And relatively, that's a pretty low-cost investment from a cost of money standpoint if you're able to take that capital in the meantime and at least put it back into, you know, some low-risk or no-risk form of money management that's not doing nothing for you but still has that powder ready to go. Any thoughts on that?

Ben

Gordon: Yeah, I mean, I would even— I didn't even go— maybe go a slightly different step, which is if you're lucky enough to have an operating note that you can, you know, draw down or kind of pay back on a variable basis, most operating notes that I know are above that 5.73%, and that's where we've seen some folks kind of use early draws of Fractal Capital until they have a longer-term investment. But I think you hit the nail on the head. There's a lot of different options that are out there. It's a unique time where I think farmers are well positioned to take advantage of equity capital because, frankly, debt capital has become more expensive for everyone, not just, not just in agriculture, and that's going to have an impact on asset appreciation. Now, I still feel confident investing in farmland because this is the best time to go get deals.

And really, I'm promising our investors that this is kind of a long-term hedge, and farmland could shoot right back up. We don't know when the next crazy event like, like COVID or another Ukraine war or something like that in today's world is. So I just say make sure when you're investing both this capital and in general, like you're thinking through the extremes and just, you know, make sure that it's nested within just that really core basic disciplined plan that fits into your broader long-term plan. So whether that's a money market or just paying down your operating note for right now, like both of them can be a good option. Or it's, you know, you're ready to go pull the trigger on an investment because you got enough buffer or you just want to keep that powder dry. Yeah.

Shay: And to clarify it and for the listeners specifically, Ben, I know you know this, but I'm just saying I brought up that example just as if you're interested in something like this and you know that there's going to be an opportunity, you just don't know when it is. Uh, it's a different way to think about how you might manage that in the interim. Uh, I think one of the last things that I had, and then I'll give you, I'll give you an opportunity to kind of wrap up some of your thoughts here, Ben, is, uh, how, you know, listeners are going to say, okay, well, what's my, what's my lender going to think of this? What's the bank? What are investors? What are my business partners going to think of this? What's your reaction to that question?

Ben

Gordon: I would say it obviously depends on the farm team. And we all know that there's a lot of personalities in this wonderful industry that we all work in. But we haven't had any difficulties with lenders, because, you know, we'll come in and we'll take a second position behind that first position lender. And really, if you think about it, and they get it pretty darn quickly, especially when they read our contract, that, you know, we're really incentivized to work with that farmer because if they default, we're in hot water way more than they are. And so we try to build these incentives not to just be strong with farmers, but also with lending partners. There's been some Silicon Valley-based startups that have come out and tried to disrupt everything and everyone in agriculture. That doesn't really make sense to me.

There's a lot of things that make sense in the industry and a lot of folks doing good work and where we can work with them and kind of add something new. We don't need to disrupt. So, you know, we offer to talk to your banker, your CPA, your financial advisor, anything, because this is a relationship where it's worth us doing that work because we don't want to do one deal with one farmer. We're not out there to make a quick buck. That's not how our investment model works. I'm going to do multiple deals with farmers that will have, you know, good, strong, growing, sustainable operations that are financially sustainable for them and their next generation. And, you know, that sometimes is going fast, sometimes it's slow and steady, but either way you got to do the work and know the people along with the numbers.

Shay: Yeah, no, great answer. Final comments, things that we haven't covered, any, any other thoughts that you have on your end, Ben?

Ben

Gordon: Yeah, I just doubled down on a lot of things I've been hearing on the podcast lately. And frankly, I've heard from some of your guys and gals that you work with, really making sure that you bulletproof your balance sheet and kind of your operation heading into the cycle that we're at. If you combine that with thinking through where you want to be in 5 to 10 years and making sure that your financial plan can actually get there, it's a crazy— it's crazy to me how few really smart operators have actually done the math on how much capital they'll need to farm the acreage target that they have for 5 to 10 years from now. And if you combine those two things, especially with planting around the corner, like go out, make sure you've done that banker meeting, that advisor meeting, like talk to those mentors..

And odds are you're going to see that, you know, you might want to, you know, add a little bit of that dry powder we've been talking about. If that's the case, Fractal.ag, give you a shout, give me a shout. My email is ben@fractal.ag. You know, we're not a fit for every deal, every person, you're not going to get a hard sell. But we want to work with folks that are, that want to be farming or have their operation still in existence and thriving in 10, 20, 30, 40 years. And if that's you, like, even if you're not working with us, just please do that, that planning ahead, because while there's definitely some hardship on the horizon, that's also a tremendous opportunity set for a lot of folks.

Shay: So I'm going to take the mic back for a minute. Said one thing come to mind, you know, we from, from round one, the first conversation that we did, I just reached out to probably 10 or 15 clients that we work with and said, you know, you might want to connect with these people. And I think you guys have connected with probably 80 or 90% of them., you know, maybe, maybe half were interested or thought it was a good fit at this time. And the other half are like, you know, not now, but I think that this is something that we're interested in. So this is, you know, the whole purpose of us doing this podcast, the Ag View Pitch in general, and also this podcast, this discussion is to provide value and perspective to people. We just really wanted to reiterate like other options that are out here as we head into this new economic environment.

And then the parting thought that I would have from a grower or a business operator standpoint is the number of operations I know of that have grown their business by 50 or 100 or 200 or 300% in the last decade is more than I can count on two hands. And it's, it's a lot. And so your point about what capital needs are we going to have, to meet our 5 and 10-year targets, it's substantial. And if you think that we continue to have, you know, whether it's higher commodity prices, higher input prices, higher land valuations, the world doesn't slow down for us. And if you're not prepared to meet it head on with square shoulders, you're going to get caught off rocking on your heels and have a challenge in front of you. So we're just really looking to help you position yourself on that. And then we do— or you guys are, you guys are having a webinar coming up here in February.

I'm going to sit in on that panel just from a discussion standpoint. If people wanted to tune into that, we'll have some details coming out on that. But anything that you'd want to mention on that in particular?

Ben

Gordon: No, I mean, I think with all this stuff, it's just, it's just helping folks to ask the questions and bring in people like yourselves that have the perspectives on, you know, what's the right position to be, especially heading in this next year and frankly, the, you know, the next 5 years. So now just appreciate the time. And at the end of the day, like every operation is unique. And we just want to see as many operations set up for success in the long term as we can.

Shay: Yeah, Ben Gordon with Fractal Agriculture, thank you for taking the time.

Ben

Gordon: Thank you, Shane. Have a good one.

Shay: And thanks everyone for listening to another episode of the Ag View Pitch, and we will catch you next time.