What's a farm worth?
This is a question that you probably think about frequently – every time you apply for a loan, hear about a land sale next door, or just assess your financial progress from year to year.
What is a farm worth? The simple answer you often hear is “whatever someone is willing to pay for it.” And that is indeed one kind of value, normally known as market value.
READ MORE: How farmland is valued
There are actually other forms of value, including liquidation value, auction value, and going concern value. Market value assumes that the buyer and seller are equally motivated, informed, and no one is under pressure to buy or sell.
Liquidation value means that the seller is under significant pressure to sell, and the marketing period will be extremely short.
Auction value assumes, of course, that the land and equipment will be sold off at an auction with a normal amount of time for marketing. When the auction is over, you’ll know exactly what the auction value was.
Lastly, there is going concern value. Going concern value is the value of the real estate plus the value of the business being conducted on the real estate.
As a farm operator, ultimately this is where you want to be; you want your business enterprise to have value. You want your farm to be worth more than just the land you work and the equipment you own. How does that happen? By setting up appropriate business structures, contracts, business relationships, and achieving above-average net income.
Consider two different farming scenarios. For illustrative purposes, let’s assume Farmer Jones has 1,000 acres in eastern Missouri titled in his own name. He grows 500 acres of corn and 500 acres of soybeans each year and sells it all at the local grain elevator.
He is a good farmer and makes a typical amount of net income for those grain acres – call it $70,000 per year. That amount of net income is baked into the local cropland values.
The Jones farming operation is very likely worth exactly what the land and equipment would bring, given an orderly sale and reasonable amount of marketing. It’s worth market value.
Now let’s consider Farmer Smith, owner of a similar 1,000 acres in eastern Missouri, as well as Smith Healthy Foods, Inc. He is growing 450 acres of corn, 450 acres of soybeans, and 100 acres of peaches, apples, strawberries, pumpkins, and vegetables. He is selling produce to local restaurants and grocery stores, running U-pick strawberry and pumpkin patches, and even running haunted hay rides and a corn maze in October. Smith is making $130,000 of net income. Does his farm operation have value beyond the land? Yes. It has going concern value.
How much? As I said, going concern value comprises the land’s market value and the business enterprise value. Since Smith is making $60K more than his prudent neighbor, Jones, I would argue that the business enterprise value of Smith Healthy Foods should be based on the excess net earnings he is bringing in beyond the net that Jones is achieving. So, you have an “excess” cash flow of $60K per year that needs to be valued. A simple way to do that is with discounted cash flows.
Let’s assume a typical investor would want to make at least 15% on his money to step into Smith’s role as owner/operator of Smith Healthy Foods. A real business valuation would have much more in the way of assumptions, projections, and math; however, a quick and easy way to get to a value is to divide the adjusted cash flow by 15%. So, we get $400,000 of business enterprise value on top of the land and equipment value.
Not bad, and Smith Healthy Foods can even move to another location, if necessary.