Evaluating Agricultural Value-Adding Business Opportunities for Equity Participation
Reviewed, August 2009
Vincent Amanor-Boadu, Ph.D.
Department of Agricultural Economics
Agricultural Marketing Resource Center
Kansas State University
vincent@agecon.ksu.edu
The purpose of this paper is to provide producers with a process (and a tool) to help them make investment decisions about value-added opportunities that come their way. It provides an objective approach to evaluating business opportunities and comparing different businesses from an investor's perspective. The paper also provides a process for potential investors to identify questions about the business for which they have received no answers from the business proponents. But most importantly, this document provides a framework for checking if all questions one has about a potential investment vehicle have been answered. By conscientiously applying the tool presented in this document to the value-added business investment decision, it is hoped that producer-investors minimize their own investment regret (regret for having invested) while contributing to the development of businesses with higher probabilities of success. The driving philosophy of this document is that every investment must be assessed for its ability to meet the investor's objectives. However, since investment in a value-adding business opportunity also transforms the marketing plans of the producer-investor, it is more important that it meets a higher level of scrutiny to minimize its adverse impact and enhance its positive outcomes.
The first part of this paper provides an explanation of business evaluation and discusses why they are important. The second part presents AgbizSMART Evaluator®, an evaluation tool that may be used to assess the investment attractiveness of particular business ventures. The AgbizSMART Evaluator® is based on the assumption that producers' investment dollars and production commitment must be put into investment vehicles that provide not only the highest potential return on investment, but have the highest probability of success. In other words, the AgbizSMART Evaluator® is a tool focused on helping producer-investors make sound investment decisions by focusing on the critical value aspects of the business opportunity confronting them.
Why Business Evaluation
Most producers interested in value-added initiatives have two principal objectives:
1. Increase the net price they get for their products; and/or
2. Benefit from the growth that the value-added business generates.
While some people may make some of these investments for social reasons, the fact remains that every investment requires some form of acceptable return to make it justifiable.
The increase in net price received for producers' products may come in the form of dividends or patronage fees the company pays after using these products as inputs in its production process and achieving a certain level of return over and above the associated costs of processing and marketing. Achieving the dual objective of increasing income and increasing wealth requires forgoing some scarce current resources such as time, energy and money. Since each of these resources has alternative uses that must be forgone if they are going to be dedicated to an investment, the potential investor needs to make sure that the income and wealth generated over a particular time frame by the business exceeds those that could be generated by the foregone alternatives. This is the rationale behind conducting business evaluation. To make sure that resources are being put into a business that will provide the best net price increase and growth over time.
Formally, we define business evaluation as the process of determining the significance and worth of a business through careful appraisal and study. Its objective is to provide a clear rationale for investing in a particular business vis-à-vis all other competing investment opportunities. Business evaluation allows potential investors to conduct their own due diligence on the business instead of depending on the analysis of others. It allows them to ensure that the promised outcomes are in line with their personal financial expectations and other investment objectives. It is important to note that while business evaluation does not eliminate investment risks, it positions investors to minimize their regret if the investment does not turn out as expected.
The usefulness of business evaluation increases as the investment cost and the cost of switching investments increases. For example, because they have relatively low switching costs (i.e., someone who would purchase the investment from the current investor), many people do not thoroughly evaluate publicly traded companies before purchasing their stock. On the other hand, since most early stage value-added businesses have high switching costs (i.e., there is no ready market for the equity or debt positions in these companies), it is critical that potential investors spend the time and effort to conduct a more in-depth assessment of the business' significance and worth.
A Business Evaluation Approach
AgBizSMART Evaluator® is a simple tool that helps agricultural producers evaluate potential investment opportunities objectively. It allows potential investors to discuss their expectations about a particular business by addressing their subjective assumptions about specific indicators of success and comparing them with assumptions presented in the business plan and those of other potential investors. AgBizSMART Evaluator® helps investors to identify unanswered or unsatisfactorily answered questions. It allows producer-investors to undertake a comprehensive due diligence of the business to assure themselves that they are making the right decision, and because it forces them to think about how current decisions contribute to achieving financial and other objectives, it creates an opportunity for them to demand the appropriate information to help them make their investment decisions. AgBizSMART Evaluator® also allows investors to compare and rank alternative businesses to facilitate the selection of the best overall business opportunity to invest in.
The AgBizSMART Evaluator® focuses on six principal categories:
1. Management;
2. Product/Service;
3. Market and Industry;
4. Finance and Economics;
5. Competitiveness; and
6. Personal Fit.
Each of the categories is weighted to reflect its potential contribution to the business' success. Within each category are specific weighted indicators which reflect their importance in the category.
The management category draws investors' attention to the people who are responsible for implementing the business plan.
The product/service category focuses attention on the product or service that the business is proposing to sell.
The main objective of the market and industry assessment is to determine if there is enough demand to justify the business' existence (credible market size) and to evaluate assumptions underlying the company's expectations about the structure and behavior of the major industry incumbents.
The economic and financial projections presented in the business plan are driven by their underlying assumptions. For this reason, it is important for investors to invest the necessary time to review their veracity and/or plausibility.
Competitive advantage is the ability to develop and implement value-creating strategies not simultaneously being implemented by current or potential competitors.
The personal fit category diverts attention to how the investor feels about the business in spite of its attractiveness vis-à-vis management, product/service, market and industry, competitive advantage.
The Decision
The AgbizSMART Evaluator® provides a decision based on a total of 1,000 points resulting from the weighted scores of individual indicators in its six evaluation categories. Each indicator in the categories can have a maximum of 10 points, which is multiplied by its weight to provide its score.
Competitive advantage accounts for 26 percent of total points (Figure 1). In other words, the competitive advantage position of the firm alone can contribute more than a quarter of its investment attractiveness. This is because the competitive advantage category evaluates the internal resources of the firm at each of its process nodes, and thus encompasses different aspects of other categories. The availability and commitment of partners along the supply chain is such a critical indicator it accounts for 27 percent of the total category points. For this reason, investors must conduct the competitive advantage analysis carefully to capture all its intricacies.
The commitment of partners is deemed important to minimize the urge to invest on the belief that markets can be created after production. If investors do not have a clear view of the market and how products are going to get to the market, the business plan is not ready in its strategic offer. This will become clear in the AgbizSMART Evaluator® results since different categories will fall short by lack of information on market partners.
The next major category is management, accounting for 20 percent of total points. Industry knowledge and network intensity indicators account for almost 50 percent of the management category's total points, implying that poor scores on these may adversely affect the investment attractiveness of the firm. The product/service category and the market and industry analysis category together account for 31 percent, finance and economics category accounts for 18 percent and the personal fit category accounts for the remaining five percent.
Figure 1: Distribution of Investment Attractiveness Index Category
The AgbizSMART Evaluator® is structured to indicate the attractiveness of each of the categories and an overall investment attractiveness index. This allows investors to determine quickly the sources of weakness and strength in the firm's evaluation. It also allows the investor to determine how easily a particular weakness can be addressed. For example, a firm with poor management can end up having a good investment attractiveness index because management can be replaced if there is a consistent indication from investors that it is a barrier to the firm's success. On the other hand, a poor investment attractiveness of competitive advantage cannot salvage the company because it cannot be changed easily. Furthermore, a poor attractiveness of the competitive advantage category will also indicate poor attractiveness in the product/service and market and industry categories if investors have performed their evaluation correctly.
Although the AgbizSMART Evaluator® is a subjective tool of how investors feel about a particular company as an investment opportunity, it allows investors to assess the assumptions underlying the firm's projections as well as their own assumptions about the firm. Its usefulness rests in the fact that if a number of unrelated investors subject the firm to AgbizSMART Evaluator® and come up with comparable investment attractiveness, it can be argued that the evaluation is objective. AgbizSMART Evaluator® can also elevate the knowledge producers have about a particular investment by transforming their mental assumptions into a tangible (written, voiced), and therefore challengeable, format. The conversations engendered by the AgbizSMART Evaluator® also help the proponents of the business to focus on the firm's weak categories, creating the potential of making a good investment even better. For example, if the evaluation consistently shows that investors do not think management has the knowledge and the network intensity to succeed in the industry, then proponents can benefit from that feedback by replacing the current management with one that possesses the identified skills and resources.
To be "GREAT", an investment must have an attractiveness index greater than 950. A "GOOD" attractiveness index lies between 871 and 950 points. An investment with an attractiveness index between 836 and 870 is "OK", 801 and 835 is "BAD" and anything below 800 is "VERY BAD." The attractiveness of the individual categories also provides insight into the sources of weakness in the firm, helping investors identify changes that may be made to enhance the firm's attractiveness. Thus, AgbizSMART Evaluator® provides a voice to producer-investors in the shaping of the firm seeking their participation. This is very important in agricultural value-adding initiatives because of the level and complexity of commitment that an investment may demand of its investors.
Sample AgbizSMART Evaluator ® Worksheet
Here is a blank form that you can use to compute the “attractiveness index” for a business in which you are considering making an investment.
Sample AgbizSMART Evaluator ® Spreadsheet
Here is a spreadsheet that you can use to compute the “attractiveness index” for a business in which you are considering making an investment.
Example
Fred B. and Spark A. use the AgbizSMART Evaluator® to evaluate their investment decision in AVAV Inc.
References and Suggested Reading
Grove, A.S. (1999). Only the Paranoid Survive, New York: Doubleday & Company, Inc.
Day, G.S. and D.J. Reibstein. (1997). Wharton on Dynamic Competitive Strategy, New York: J.W. Wiley & Sons, Inc.
Barney, J.B. (2000). Firm Resources and Sustained Competitive Advantage, in J.C. Baum and F. Dobbin (eds.), Economics Meets Sociology in Strategic Management, Stamford, CT: JAI Press Inc. pp. 203-227.
Robinson, Marc. (2000). Essential Finance: Investing Basics: Make Smart Decisions without Being an Expert, DK Publishing, Inc.
Nofsinger, John R. (2001). Investment Madness: How Psychology Affects Your Investing . . . and What to Do About It, Upper Saddle rive, NJ: Pearson Education.
Goldratt, Eliyahu M., Eli Shragenheim, with Carol A. Ptak. (2000). Necessary But Not Sufficient: A Theory of Constraints Business Novel, North River Press, Inc.
