We often get asked what level of equity should I be aiming for in my business? While there are some industry benchmarks, and good technical reasons for having a certain level of equity, the answer really is “it depends”.
A persons approach to risk will be a major factor that will influence comfort in a particular equity level. It’s important to understand that no risk position is right or wrong, it’s what you are comfortable living with. Personal attitude to risk will depend on a range of factors, including:
- Financial security
- Stage of life
- Family circumstances
Attitude to risk will change throughout life and can sometimes change rapidly, often triggered by sudden events.
A good example of changing approach to risk is to think about a young, passionate, enthusiastic farmer who is wanting to increase their scale and grow the business. They will be more comfortable with a lower level of equity than a farmer who is approaching retirement, and is wanting some certainty and security about their ability to fund a more relaxed way of life.
Often 80% equity is used as a good mid-range benchmark for an appropriate equity, with greater than 90% being very strong and less than 70% being weak. There are arguments that a business with high equity may have “lazy” capital, suggesting that increased borrowing may be an appropriate strategy to grow wealth. Alternatively, there have historically been many business that have been highly profitable with well less than 70% equity. At peak debt, just prior to harvest, many cropping businesses report an equity of 60%.
A range of other factors need to be taken into account, such as climatic security of the farm location, what enterprises are being farmed, what is the skill of the business manager and what other risks might the business be exposed to.
What’s probably most important is to actually calculate your own equity accurately and regularly, and to understand your own personal and business current situation and future aims well enough make informed decisions about your own circumstance. These are about as big as decisions get in farm business, so make sure you contact one of Meridian Agriculture’s Farm Business Consultants on 03 5341 6100 to help guide you.
Article by Paul Blackshaw