Family Farm Business Structures | Livelihood & Legacy Part 2
By Amanda Smith
In the first article in this series, we addressed the issue of fairness, and how that impacts the residual profitability and sustainability of a family farm. In this installment, we will take a look at various business structures and their benefits and challenges as it relates to transitioning the family farm from one generation to the next. According to the 2014 USDA Family Farm Report, about 32% of farm operators in the U.S. are at least 65 years old. This translates to 1/3 of the family farms in this country facing imminent transfer of management and ownership in the immediate future.
You may be asking yourself the question “When do I need to begin thinking about how my farm will transition after my retirement or death?” The answer to that question is variable based on your particular family situation, but generally you should be addressing succession planning around the time that your children reach adulthood and are making major life decisions.
If you have a child who has shown interest in the family farm all along, and they are preparing to enter college, perhaps a discussion should happen about their choice of major as it relates to the farm. What is going to be needed in terms of personnel in your operation, and what are the strengths of the child compared to the current managing generation?
If marriage appears to be in the near future for a child, you may want to consider the ownership of farm assets and protecting them in the unfortunate case of death or divorce. The National Center for Family and Marriage Research at Bowling Green State University estimated in 2012 that about 10 in every 1000 farm couples divorce each year, and because there are many issues of property ownership, retirement distribution, debt responsibility, inheritance, and child custody with farm seasonality, these divorces can be cumbersome, expensive, and incredibly destructive to both the operation and family relationships.
I hate to use this old cliché, but when it comes to farm succession and estate planning, failing to plan can most definitely by planning to fail. The business structure chosen for your particular operation can greatly impact the way assets are owned and transitioned from one generation to the next.
While you should certainly consult with your advisors prior to making any decisions, this can give you a simple overview of the options and how they impact succession planning.
The first business structure we will address is that of sole proprietorship, where all assets are held in the name or names of the current generation. With regards to succession planning, farm assets can be gifted and/or sold to the next generation upon death. With sole proprietorship the current owner maintains all ownership and management control until they either choose to retire or pass away.
The challenge with sole proprietorship arises when decisions are not made about the operation and estate and the current owner becomes disabled to the point of legal incompetency. At this juncture, decisions about the transfer of assets and management can end in a court decision that may or may not reflect the wishes of the owners. Often times, when a family farm is owned and managed in this way, delaying decisions about future management can cause the most competent potential heirs to lose patience and pursue another livelihood. The other major issue of failing to plan in this case is the obvious discord that can develop between siblings who have to agree upon distribution of farm ownership and management, while at the same time processing the loss of their parents.
Let us transition to farms which are operating as corporations, and the current generation owns the majority of voting shares. Much like sole proprietorships, corporation shareholders maintain ownership and management control until retirement or death. Also like the previous structure, if they should become legally incompetent to make business decisions and no estate plan exists, court decisions are often needed.
The transition of shares upon retirement or death usually is an equal distribution of the voting shares amongst all heirs, which also allows for equal distribution of net profits, even when management is not shared equally. In order to compensate the heirs managing the farm, a salary can be paid (which reduces net profits to all shareholders). Another option is to assign the managing heir(s) a larger percentage of voting shares, and therefore net profits.
The third and final structure we will observe is that of the limited liability partnership or LLC. Within this structure there are two types of partnership units. General Partner units are held by those with who are providing daily management. Limited Partner units are held by entities who will receive a proportionate share of the net profits upon decision of the General Partner to make a distribution.
The General Partner in an LLC has the authority to designate their immediate successor, along with providing language in the partnership agreement that outlines parameters for transition of the General Partner shares for the entirety of the operation’s existence. The General Partner will maintain a share of the Limited Partner units to provide income as is deemed necessary, and can distribute the remainder of the Limited Partner shares to heirs both during their lifetime and upon death.
The benefits of LLC structure is the ability of the General Partner to stay in control of the operation with provision made for their successor at any time they wish to transfer it, including at death or upon legally incompetent disability. During their lifetime, the General Partner can gift Limited Shares to heirs and/or charitable organizations.
The major disadvantage of and LLC would be where heirs lose patience with not having a share in management decisions, and only having a right to profits when the General Partner deems it necessary. There are no guaranteed profits. In the case of an LLC where the General Partner is transferred to the managing heir, and the Limited shares are held by the remainder, those holding only Limited Partner shares can likely only force a distribution if they can prove the General Partner is withholding profits deceivingly or being fraudulent.
“In this world nothing can be said to be certain, except death and taxes.”
While you process through each of these business structures and their implications for your own family’s farm operation, look forward to the next issue of this series which will address tax implications as they currently stand for transferring farm and land assets.
*A large majority of the above information was adapted from a presentation by Laura Hansen Dean to local agriculture producers and leaders in Benton County, among other sources. It should not be taken as legal advice. You should always consult with your individual advisors before making any legal decisions. Information gathered from sources deemed reliable but not guaranteed, subject to change without notice.