Critics warn that many of these farmer-launched manufacturing enterprises remain commodity businesses where only the world’s lowest-cost operators can thrive. With just three or four multinational players dominating some food and fiber industries, small independent operations can lack the scale, market access, technology innovation, capital reserves and sophisticated risk-management skills needed to compete and to survive inevitable down cycles. As global trade is liberalized, South American exports of both ethanol and soybean meal pose potential challenges to high-cost, domestic operations that lack economies of scale. Conflicts inherent in co-op structures also can lead to management difficulties (see Chapter 5) that put farmer ventures at a competitive disadvantage compared to corporations or private partnerships. Of particular concern to bankers is the tendency of farmer owners to tolerate running value-added ventures at a loss so long as they profit from a higher price for their raw commodities.

Despite those caveats, farmer ownership of rural-based businesses makes sense as a way to diversify the sources of farm incomes and to rebuild rural communities. Northwest Iowa, Minnesota, the Dakotas and Kansas have experienced a flowering of value-added farm enterprises in the last decade. Although their prices were relatively low compared to the Eastern Corn Belt, their experiences could prove valuable to farmers and agriculturally-based communities nationwide.

The Task Force attempted to identify elements that incubate and foster successful rural-based businesses (see observations on page 17). During site visits and interviews in the spring of 2004, task force members focused on characteristics that have helped farmer-owned ventures weather start-up difficulties and/or unavoidable spikes in commodity prices. Each of the following case studies incorporate principles—such as economy of scale, unique competitive advantages, risk-management and/or a shift toward non-commodity products—that increase the odds of sustaining profits.

South Dakota Soybean Processors (SDSP)

• Volga, S.D. (founded 1996)
• Expanded from original 16 mil. bu. to 28 mil. bu. annual capacity
• Emphasizing value-added soy products, with a goal that they will generate 60% of revenues
• Invested in a supplier of soy-oil based polyol, a product used in polyurethane plastics

Minnesota Soybean Processors

• Brewster, Minn. (founded 2003)
• Launched a 36-mil. bu./ year processing plant under joint management with SDSP
• Benefits from SDSP’s risk-management experience and marketing contacts
• Secured over $32 million to build a soy processing plant and a 30-million gallon soy diesel plant (to qualify for Minnesota’s state biodiesel mandate)

In 1993, a group of South Dakotans attempted to remedy some of the worst local soybean prices in the nation by launching South Dakota Soybean Processors. They wanted to proceed with a feasibility study by the South Dakota Soybean Research and Promotion Council that had recommended the construction of the state’s first soybean processing plant, and the nation’s first new plant since 1978. No private processors were willing to take the risk.

South Dakota farmers recognized early in the decade that with Freedom to Farm legislation and conservation tillage, the state was evolving out of low-profit wheat production and into a soybean and corn powerhouse. In fact, the state added 143% more soybean acres from 1993-2003. In an attempt to become “price makers, not price takers,” some 2,100 members formed South Dakota Soybean Processors, and eventually built a 16 mil. bu./year crushing facility that opened in Volga, S.D. in 1996.

The launch’s timing couldn’t have been worse: In 1996, soybean prices hit an eight-year high. Despite the difficult startup, SDSP managed to distribute dividends even in the industry’s most challenging years. Today, the plant crushes 25% of South Dakota’s rapidly growing soybean acres and is considered one of the nation’s most successful value-added experiments. In the first five years of operation, local soybean basis (the difference between Chicago and local markets) narrowed 25¢/bu. and profits more than repaid members all of their original stock investment. Perhaps most significantly, SDSP inspired Minnesota Soybean Processors to build a 100,000 bu./day crush facility in 2003. Together, the two operations are owned by 4,400 family farmer members from 28 states and represent over $100 million worth of capital investment.

Future direction. But the future poses some serious challenges. Erosion in South Dakota’s livestock numbers means local demand for soybean meal is one-third smaller today than eight years ago. Soybean oil is normally a cheap commodity that represents 30% to 35% of the plant’s income stream. Industry analysts also worry that opening the Brewster site within close proximity of a new 100,000 bu./day CHS soybean processing plant could inflate local soybean prices to the detriment of both plants.

However, supporters contend that adding the facility in Minnesota makes sense. Combining forces saves the two entities approximately $500,000/year in marketing costs and allows for joint management. What’s more, Minnesota had been processing only 37% of its soybeans, versus crush rates of about 77% in Iowa and Illinois. A Minnesota state law mandating 2% biodiesel is providing new impetus for investment. Before the mandate can take effect, Minnesota plants must be capable of producing half the 16-million gallon market.

To adapt to changing circumstances, SDSP directors have modified their original vision. First, they converted the organization from a co-op to a limited liability company so as to gain the flexibility of building equity capital. Over the next 5-7 years, they hope to earn 60% of revenues from value-added income streams and rely less on commodities like meal and soybean oil. One promising alliance is a joint venture with Urethane Soy Systems Company, a research and marketer of SoyOylTM to produce polyurethane products from soybeans. SDSP first entered into a supply agreement with the company in 1999, but in 2003 became the majority owner of the company. Markets SoyOyl has developed and served include soy-based carpets, spray insulation, rigid foam insulation and truck bed liners. Customers include Dow Chemical Company, Bayer/John Deere and Ford Motor Company. SDSP secured a patent on the process in 2002 that offers advantages through energy reduction, elimination of product shrink and reduction in variable costs.

The organization’s leaders are preparing to take advantage of the increased demand for motor fuel, the support for renewable fuels in the farm bill and the prospect of a renewable fuels mandate. By mid-2004, Minnesota Soybean Processors successfully completed a $7.2 million equity drive to build a biodiesel refinery and thus qualify for new state incentives for soy diesel production. It is scheduled to open in 2005.

VeraSun Energy

• Aurora, S.D. (Opened 2003)
• 100-million gallon/year, dry-mill ethanol plant
• Benefits from economy of scale as one of the largest dry-mill plants in the country
• C-corporation owned by a South Dakota entrepreneur and eight nonfarmer investors
South Dakota’s largest ethanol plant illustrates some of the advantages of scale and business structure that are atypical for the industry.

VeraSun investor and South Dakota native Don Endres first founded and sold two technology companies in the 1990s. Looking for a new business opportunity, Endres then invested in two 40-million-gallon ethanol plants, one a cooperative and another a limited liability company.

Rather than limit the size of this new plant based on the amount of capital they could raise, VeraSun’s managers focused on plant economics, engineering and environmental constraints. They determined that a plant properly located with 100 million-gallon capacity created optimum efficiencies and distribution of ethanol.

The optimum business structure also entailed one that could attract a few additional investors, while giving them the ability to make decisions quickly. The one-man, one-vote method common in co-op structure make it difficult to attract outside capital from large individual investors. In addition, corn delivery requirements, transfer restrictions and lender covenants requiring members to deliver corn below market during difficult times also created barriers to VeraSun’s potential non-producer investors. These restrictions also tend to reduce shareholder value over the long term.

The owners decided that a C-corporation best fit the needs of private equity investors. It offered them voting control proportionate to their investments and no corn delivery requirements. It also enabled the company to assemble a nimble, five-member board comprised of both company and industry leaders.

“The cooperative business model is an effective one for large numbers of producers to pool their financial resources and business experience.,” says Endres. “By contrast, a corporate structure is a good model if investors want management to focus on profitability. Both structures create local economic development through new corn markets and jobs. Both have the ability to increase the value in the ethanol business. The decision of structure really comes down to the primary objective of the investor.

”VeraSun’s experience indicates that the farm-ownership model may need to adapt as the ethanol industry gravitates to larger plants. Such operations are increasingly financed by six to eight principal investors, without the need to deal with hundreds of small-scale farm investors. An innovative group of Michigan farmers solved the problem by forming their own co-op entity that became one of a handful of owners of an ethanol plant. The farmer-entity holds one spot on the board of directors, minimizing logistical issues. But the benefit of the arrangement is that farmers can retain local ownership and stay in the equity stream while investors earn goodwill in the neighborhoods where they locate.