How some FPC balloons can become durable high flyers – II

As noted earlier, despite the inherent problems with group enterprises, of which class farmer producer companies (FPCs) are a sub-category, there is a need for these enterprises to provide a measure of stability to farm incomes. I had addressed the class of problems connected with member-FPC relationship in the earlier note. READ: How some FPC balloons can become durable high flyers – I. Here I look at the issue of capitalization of FPC and issues connected with it.

FPCs are for doing business. Any business needs capital infusion. Capital can come by way of equity, by way of grants, by way of profits ploughed back in business, by way of trade credits and advances or by way of formal institutional or informal loans. I try and see the relevance and possibility of each of these.

Need for capital

The amount of capital needed would vary by the nature of business. For an FPC engaged in merely pooling demand for inputs, going to the market with a pooled bulk demand, collecting and transporting goods back to villages and distributing each farmer’s order against cash – the capital requirement will be minimal. It will be only for the purpose of arranging its office space, local storage, phone for staff and the like.

For an FPC that procures a produce such as, say paddy from farmers, processes it to produce rice and markets it through a retail chain under its own brand, the need for capital will be much larger. It will need money for building a plant and installing machinery, creating storage for paddy and for rice, creating and building a brand for its packed rice and of course manage its office, transport vehicles and so on.

Thus the extent of capital needed varies a great deal across FPCs depending upon the business they get into. Some FPCs could start small and add on more and more services and stages of processing in their business as they grow.

Avenues to raise funds

It is to be noted that almost at each stage of its growth, FPCs shall experience acute paucity of capital. FPCs cannot receive equity capital from individuals who are not producers of the commodity concerned or farmers who can be potential producers. Capital must be contributed only by producer members.

Hence FPCs’ own (that is non-debt) funds can come either by way of equity contribution by members or by way of reserves built out of retained earnings. Capital grants given by governments or donors are another source of owned funds.

For conducting its business, an FPC can raise debts either in the form of long term debt or short term working capital gains and can also avail credit from suppliers and advance payment from buyers of produce during the course of its business.

FPCs’ share capital

The reality is that most of the members of an FPC are poor farmers. They have a severely limited ability and possibly uncertain willingness to invest their scarce savings in the share capital of the FPC. If they expect the FPC to transact with them even when they do not contribute equity capital, they would possibly completely refrain from making this contribution.

Assuming that each member can and is willing to contribute Rs. 1,000 towards share capital of the FPC, a typical FPC working in 20 to 30 villages each with 100 potential members can hope to mobilize at best Rs 3 million.

Assume that they get a grant of Rs 2 million from the government. Thus its owned funds will be Rs 5 million. With great reluctance banks may lend up to, say Rs 10 million. Thus its total funds will be no more than Rs 15 million.

For an FPC engaged in business in single harvest produce, it can then have at most the capacity to buy produce worth Rs 5,000 from each member if it were to try and follow a buy-and-hold strategy for their produce.

This would be a grossly insufficient number as it will perhaps account for no more than a tenth of a typical member’s total produce. While specific numbers can be debated, the clear lesson is that within the overall funds available to an FPC, it can only be a bit player if it ever considers adopting a buy-and-hold strategy for members’ produce. 

Unfavorable banks

In the above paragraph, I had implicitly assumed that the bank would accept a debt/equity ratio of 2. This is done arbitrarily here and is a matter of both priority sector related banking norms, the experience of the local branch with farm related lending and the risk appetite of the bank manager.

The tragedy is that FPC usually has nothing to offer by way of a collateral and a long history of loan defaults and delinquency on the part of farmers (for quite genuine reasons) has made the old maxim of “capitalization of honesty” into a poor joke.

So the banks are generally not keen to lend to FPCs unless forced by government policy. Even when they do, the interest burden of 14-15% is so large as to wipe out much of the trading margin of the FPC. Thus borrowing for business in produce with thin margins is really not a good idea, and excessive borrowing is bad business.

The worst case scenario, not always avoided, is for the FPC to borrow in informal market or from non-banking financial companies (NBFCs) at high interest rates and then invest it in stocks of goods in the hope of a favorable price movement. A large number of businesses have been ruined due to speculation on borrowed money.

Guidelines:

So how should an FPC run its business within limited capital? There is no point wishing away the critical nature of the funds problem. This is a tough problem admitting of no easy solution. Any quick and dirty solution is more likely to lead to ruin than to sustainability of the FPC.

No one has really solved the problem of under-capitalization and of inadequate working capital for operations in seasonally produced commodities. Here are some suggestions about what to do. I shall also offer some suggestion about what not to do. Clearly, not every “to do” may be feasible in given local conditions, nor every “never to do” completely avoidable. But this is a suggested guideline.

To do:

While undertaking input operations, please ensure that members deposit at least a significant portion of the cost of their requirement when placing their order. This should be insisted upon whenever the FPC is not being promoted by an agency that also has SHGs in the same area. If there is an SHG, there is a sort of built-in assurance in the form of savings of the household.

• Begin really small: just pooling demand, ensuring a fair negotiated deal with a supplier, facilitating transport and distribution for him and undertaking logistics if at all compelled. In effect, start as a local distributor of the supplier for a fee.
• The next step in the input business could be to assume dealership of the input supplier if the assessment shows that there is a reliable demand for the input in your area. This will involve investment in shop/warehouse space, deposit with the district level distributor etc. and hence can be done only when the FPC has accumulated some retained earnings.
• While engaging in output marketing related activity, to start with, the FPC may engage only with government’s price support agencies and act as their sub-agents. This will involve a minimal funds exposure and serve as a good training ground for efficient operations. FPC will need to ensure that produce quality as received from members adheres to norms specified by the government agency.
• Unless specific donor funds are available for setting up processing facilities, and if the FPC must process the produce, FPC should work in processing only on lease or job-work basis.
• FPC must ensure that of every incremental gain made by members, a portion is contributed towards equity capital each year. FPC may also encourage all desirous members to save money with it or with the SHGs associated with it so that those funds can be used for working capital.

Never to do:

• Deposits with suppliers who appoint the FPC as their local delivery agent, needs capital. FPC is short of money. Yet no one will give products to a nascent FPC without deposits. Hence to the extent possible, FPC should minimize the amount of deposit money for obtaining dealership etc. from input supply agencies.
• FPC should rely as much as possible on rented vehicles, office space, warehouse space, etc. and not try to buy these. This will reduce its fixed investment making it available as working capital.
• FPC should not agree for immediate payment for member produce on borrowed funds resisting member pressure as much as possible.
• FPC must not adopt procure-and-hold strategies for farm produce unless it also has the capacity to simultaneously hedge in commodity futures. I see a village level FPC needing time to acquire the savviness for the latter and hence recommend minimal reliance on buy-and-hold strategies.

Sanjiv Phansalkar is associated closely with Transform Rural India Foundation. He was earlier a faculty member at the Institute of Rural Management Anand (IRMA). Phansalkar is a fellow of the Indian Institute of Management (IIM) Ahmedabad. Views are personal.